What is a Market Correction?
As frequent as market corrections are, some investors, both in the stock market and the crypto market, still don’t know what to do when it happens. If you fall under this category, this post is for you.
At the end of this piece, you’ll understand market correction and the differences between a bear market and a market correction. Also, you’ll have a better idea of what usually happens during a market correction and what you should be doing when there’s a market correction. (hint: panic selling isn’t on the list of things to do.)
Bear Market Vs. Market Correction
In simple terms, a market correction is a moderate decline in the value of financial security from its most recent peak. Security in this sense could mean an individual asset such as a stock, bond, or crypto asset. It could also mean an index measuring a group of assets. It’s referred to as a correction because the decline is relatively small, and in the case of crypto assets, it would mean that the coin has probably rallied too far from its established trend.
The next question you are probably asking is what amounts to a “moderate” decline? Generally, a moderate decline is considered a drop in the value of an asset that is more than 10% but not greater than 20%.
When the drop passes the 20% mark, it’s no longer a market correction but has become a bear market. A bear market is generally defined as a prolonged drop in the value of an asset, generally when prices fall by 20% or more from their most recent high. A market correction could last for hours, weeks, or months, but a bear market usually lasts longer than a correction as it could last for years. However, what signifies if it’s a bear market or just a market correction is more about the depth of the decline rather than the duration of the decline.
What usually happens during a correction?
One obvious thing that happens during a crypto market correction is the drop in the prices of the crypto assets. It’s usually a sign that, for different reasons, traders and investors believe the current price of the crypto asset is too high, and they wouldn’t want to tie up their capital in the asset. As a result, individual assets during a market correction tend to perform poorly due to unfavourable market conditions.
However, if you are a strategic investor, periods of market correction could be the perfect time for you to buy high-value crypto assets at lesser prices. It’s, however, vital that you check the trends to ensure you are making your decision from a well-informed perspective, mainly because there could be further declines in the value of the asset leading it to a bear market or even a potential crash.
Market corrections tend to hurt short-term investors but could be very beneficial to long-term investors who have a strategy for managing the risks of the market.
How long does a correction last?
As earlier mentioned, a market correction could last for hours, days, months, or years. The average stock market correction takes about six months to find a bottom. Since corrections usually aren’t as deep as the bear market, they tend to be shorter. It is particularly true in the crypto market, where it isn’t uncommon to see market corrections lasting for only a week or even just one day. Usually, corrections are followed by recoveries, although there’s a possibility that they could lead to prolonged periods of decline. You know a correction has ended when the price reaches a new high.
In the cryptocurrency market, it would appear that corrections ranging between 5% and 10% occur more frequently than in the stock market. However, that is equally balanced out by the more frequent recoveries. The fact that so many major coins have been bullish since the inception of the crypto market is a clear indication. For instance, BTC has grown from as little as $0.003 per coin in 2010 to over $31,000 in 2022. That is despite the frequent corrections that this coin frequently experiences.
What to do during a correction
- Understand the cause of the correction
The first step you should take during a correction is to understand the cause. Common causes of cryptocurrency market correction include buyers running into supply issues and cases of a strong sell sentiment resulting from market news such as hacker attacks on blockchain platforms, among several other causes. Understanding the cause would help you know whether to prepare for an extended market correction or a bear market.
- Dollar Cost Averaging
Dollar-Cost Averaging (DCA) is one crucial strategy that should guide your decision during a market correction. With DCA, you divide your total investments and initiate regular, systematic entries into the market. This strategy would help reduce the effects of price volatility since you’ll sometimes buy at higher prices even though you are also buying at lower prices.
It is probably one thing every crypto investor is familiar with. As a crypto investor, you’ll achieve more success if you always have sufficient cash to buy dips. Avoid pulling out of the market when prices are dropping since the prices would recover at the end of a market correction. Instead, use this as an opportunity to buy more coins.
- Review your risk tolerance
You want to review your risk tolerance after a market correction as an investor. If you are a first-time investor, the best time to know your risk tolerance is during a market correction. You should review your risk tolerance from time to time and make sure you build a portfolio that matches it. Especially for first-time investors, it’s essential that you only invest money you can afford to lose and also diversify your portfolio as much as possible.
Wrap Up
You shouldn’t panic about a market correction since it’s a normal part of any financial market cycle. While it is true that market corrections aren’t easy to explain or predict, it’s easy for you to prepare so that you can position yourself to take advantage of the declines.
