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As we have seen over the past decade, bull markets can last for a long time. But occasionally, the bull market goes too far, causing prices to fall unexpectedly. When stocks or other financial instruments suddenly fall during a bull market, the phenomenon is called a market correction because prices are “correcting” back to their natural trend. Let’s take a closer look at how a market correction is defined and how it affects day traders.
What is the significance of the market correction?
In financial markets, a correction is usually considered to have occurred when major stock indexes such as the Dow Jones Industrial Average or the S&P 500 index fall more than 10%(but less than 20%) from their recent 52-week highs. While 10% is in some ways an arbitrary threshold, it tends to indicate that investors and traders have become more pessimistic about the market. As we said earlier, this is called a correction because traditionally declines tend to “correct” and bring prices back to their long-term trend. Traders and investors often use this term to describe a pause in the market, but not a coma. Think of a bear market as a hurricane and a correction as a shower. A bear market is a more severe and often more sustained market decline that occurs when stocks fall 20% or more from a recent high.
The last bear market began on February 19, 2020, during the COVID-19 outbreak, and lasted until March 23, 2020. The S&P 500 subsequently fell nearly 34 per cent from its peak to its low. The last bear market occurred during the global financial crisis. From the market’s peak in October 2007 to its bottom in March 2009, the S&P 500 fell 56% Why did the market correction happen?
Market corrections are usually caused by economic developments, such as rising loan defaults or long-term unemployment. In the case of a stock, a correction could be due to a disappointing earnings report or other emotional event. If there are some changes that weigh on the market, it could be a sign that you need to prepare for a long-term correction that could even turn into a bear market. After an economic shock or major political event that could trigger a correction, stocks typically recover and continue to edge higher.
How often does the stock market correct?
CNBC and other business news stations start using the word “correction” when stocks rise steadily for a long period of time. According to Yardeni Research, the S&P 500 has gone through 11 corrections in the past 21 years, including only two bear markets. The last US stock market correction ended in September 2020. A market correction in September 2020 sent the S&P 500 down nearly 10% due to concerns about the spread of COVID-19, with the biggest gainers falling even more. Whatever the reason, the ninth month is historically the worst for stocks. Since 1928, the S&P 500 has lost an average of 1% in September. February and May were the only two months with negative average returns, of minus 0.1 per cent each. In fact, September is the only month with fewer years of decline (42) than increase (50).
What to do during a market correction
No one can predict with any degree of confidence whether a correction will turn into a bear market or a reversal. Traditionally, however, most corrections do not turn into bear markets. But what if the pullback really is the start of a bear market? Well, there is no bull market forever, and even though corrections and bear markets are terrible, day traders can expect them to happen once in a while in their lifetimes. Therefore, it is important to use a day trading strategy, which may benefit your emotional health and your portfolio in the event of a major downturn.
Intraday trading during a market correction
Market corrections have little effect on day traders. If anything, the adjustment actually offers greater trade opportunities.
Keep in mind that market corrections bring volatility, characterized by large price swings and heavy trading. Volatility is usually caused by an imbalance in trading orders in one direction (e.g., sell only, not buy).
Therefore, short-term traders should accept the correction and look for shorting opportunities during these downturns. If you’re a day trader and like to be long, you can stay focused
Stocks that dominate the news because they tend to be volatile enough to pull the market out of its doldrums.
Gold and other stocks related to precious metals
Exchange-traded funds (ETFs) as opposed to indices
Here are two more important things day traders should consider as the market corrects: