When the stock market rises steadily for several months or longer, investors might start wondering when a so-called correction is due. “Stock market correction” is a term used to describe a stock market index's fall from a recent high. Seeing a portfolio value tumble can put any investor on edge, but these slumps occur frequently and are a normal part of long-term investing. Understanding what market corrections are and why they happen can help investors manage their portfolio during these times.
What is a stock market correction?
A stock market correction is a temporary decline in the value of an index or the price of an individual asset. Investors often use this term when an index falls between 10% and 20% from a recent market high. That’s where the “correction” part comes in: The drop often returns the index or security to what investors believe is its true long-term value.
Individual stocks also experience ups and downs, usually with more volatility. When a stock reaches a yearlong high of $100 per share, for example, a correction would occur if the stock price falls to between $90 and $80.
Investors have a lot of terms for describing market activity. Although there are no hand-and-fast rules about market terms, a correction differs from a dip, which is a small, brief market downturn, and from a market crash, in which stock prices fall sharply on a single day or week. Then there are bear markets, when stock prices experience a larger, more sustained decline of at least 20%.
Causes of a stock market correction
The reasons for a one-day drop may vary, but a market correction is usually triggered by an event such as a slowing economy or fear in the market. For instance, investors tend to chase returns or follow trends, which can help push stock prices up. But as this happens, some investors may decide to sell in order to turn a profit while the price is high. This can cause the stock price to drop temporarily, which may result in a correction. This can also happen on a larger scale as confidence in the market wanes.
Stock market corrections may also happen when the economy starts to slow and companies earn less, or when investors get spooked by matters out of their control. For instance, expectations of rising interest rates or inflation, political uncertainty, trade wars, and global health concerns can cause fearful investors to avoid the stock market or sell stocks in favor of safer assets.
How long market corrections typically last
Market corrections tend to be short-lived, but it’s impossible to predict how long one will last. The S&P 500 index has experienced 27 corrections since 1945, and the average stock market correction lasted about four months. But the market doesn’t always rebound right away. Three of the S&P 500 corrections between 2000 and 2019 transformed into a bear market, or a stock index drop of 20% or more, while another turned into a recession. The other declines eventually returned to bull markets.
Historical examples of market corrections
While the frequency of market corrections depends on factors like investor sentiment and the overall economy, historical data show these slides happen about every 16 months. Some last only a few weeks, while others are longer and more memorable.
In 2018, the S&P 500 dropped at least 10% in the first quarter of the year and again in the fourth quarter amid political dysfunction, a global economic slowdown, and other concerns. Nasdaq and Dow Jones also experienced corrections.
Concerns over the economic fallout of the Covid-19 pandemic interrupted a historic bull market in February 2020. Within the following month, the Dow, Nasdaq, and S&P 500 all experienced market corrections and then declined into bear-market territory.
In both cases, those indexes rebounded within a few months and went on to set new records.
Stock market correction vs. bear market
The difference between a correction and a bear market is the length and depth of the decline. Every market correction is different, but the stock index typically declines between 10% and 20% for a period of about three to five months.
Bear markets start when the index declines by more than 20%. Since World War II, bear markets have lasted 14 months on average, and the S&P 500 index has fallen an average of 33% during those downturns. Bear markets last longer than corrections because they’re usually the result of a genuine economic issue rather than investor anxiety or a temporary disruption.
What happens to your portfolio during a correction?
During a stock market correction, the value of portfolios will drop if investments are tied to stock market indexes such as the S&P 500 or Dow Jones Industrial Average. But because every investor’s portfolio is different, the exact change in holdings may be different from what’s going on in the index. So even if the Dow Jones falls by 10%, for instance, some portfolios may only go down 8% although others may decline 12%.
FAQs about stock market corrections
Can you predict a market correction?
While some analysts have predicted when a stock market correction is coming,
they’ve also been wrong. For instance, the Dow Jones Industrial Average experienced steady gains between 2013 and 2018—and despite many predictions of an impending market correction, there was no meaningful pullback during this time.
The takeaway? It’s impossible to know exactly where the market is headed at all times.
How to prepare for a stock market correction
There really is no way to prepare for a market correction. Pulling out of the market every time investors anticipate a correction could backfire because they may predict more than actually occurs. If they move their money to cash, they could end up missing out on the best-performing days of the market and lower their long-term returns.
Do corrections always turn into a bear market?
The short answer is no, although it’s impossible to predict when a bear market is on the horizon. Since 2000, four market corrections have transformed into bear markets. But a correction has a higher chance of turning into a bear market if significant underlying issues are influencing the market. For instance, fears over the real estate bubble helped push a market correction into a bear market in October 2007.
Is a stock market correction coming?
It’s fair to say a correction will happen at some point. History shows they have happened regularly in the past, and there is no reason to think they won’t happen again in the future. The great unknown is when, and no one really has the answer to that question.