What is a correction? Well, the web definition is “that which is substituted in the place of that which is wrong” or “rectification, the act of offering an improvement on a mistake; setting right”. Of course, since this is a financial blog, we are talking about a market correction. Mostly because any time you turn on a financial show, they are talking about how “the correction is coming!” Ahhhhh, run for the hills!
I’ve been wanting to write this blog post for a while, but I figured I’d wait until we were already close to a correction so that it would be a little more relevant. That way, hopefully there won’t be a huge level of panic when we actually reach the correction mark.
A market correction is defined as a reverse movement, usually downward, in the price of an individual stock, bond, commodity or index. The percentage change required in order for it to be considered a correction is 10% or more. If the prices do not recover fairly quickly, then most analysts think that there will be a bear market. For those who think that: News Flash! We have been in a bear market for quite some time.
What most are talking about however, is a correction to the recent rally from last March. Some feel that prices rose too quickly and thus a correction will occur. In and of itself, and in the grand scheme of investing (especially if you have a long time horizon), corrections aren’t bad. They are simply an adjustment to the market when securities have become what is known as “overbought”, which just means what it says.
So, did the market rise too far too fast? Well, some people certainly think so. The interesting thing is that everybody has an opinion on this (including me), but that opinions are not what moves the markets, investors are. But if investors are scared that a correction might occur, what will happen? The market will become “oversold” which creates a buying opportunity.
But wait Mike, you say. The markets are efficient, everyone says so. Well, if the market can be oversold and overbought, I submit that in fact the market is NOT efficient. In fact, in volatile times like this, I’m would compare the stock market to a Hummer that gets 6 miles per gallon. Terribly inefficient.
What is the point of all of this? Don’t fear a correction. When the market corrects, it’s a little like when you first started driving. You always over-corrected when you changed lanes or turned or recovered from a turn. You usually will get where you are going, you just might get out of whack on the way there. Bottom line, use downward price movements to add to your portfolio in a tactical manner (read: Don’t just buy some random stuff).