In the stock markets, a correction from time to time is inevitable. A stock market correction is defined as when the markets fall 10 percent from their 52-week high. It is a natural cycle in the stock markets and is usually seen after every bull run.
When markets have been on an upward trend for a while, a stock market correction helps to consolidate the market and lower the valuation of stocks, making them easier to buy. Even though new investors may panic during such corrections, it is always welcomed by experienced investors. It gives them the opportunity to buy more stocks at a lower rate.
These corrections are generally a short-term phenomenon lasting only a few days or weeks. It is not the same as a crash.
How to be prepared
While a stock market correction can start at any time, it is important for investors to always be prepared. The best strategy to prepare for this is diversification. It is important to diversify your portfolio in order to provide a cushion in case of a correction. along with stocks and equity funds, your portfolio should also include bonds, gold, commodities, etc which does not move in tandem with stocks. So in case of a stock market correction, there are assets that are moving in the opposite direction as well, capping your losses.
Another important thing to keep in mind is that do not try and time the market in case of a correction, it can lead to massive losses. Generally, investors who ride out the correction benefit more than investors who panic and withdraw funds.
Why should you buy during a correction?
Many experienced investors see market corrections as an opportunity to review and rebalance their portfolios. While they like to be prepared for sudden market movements, a correction is an apt time to buy more stocks. Here's why you should too:
Decrease in valuation
A correction in markets helps decrease the stock prices, making them more attractive to investors. You can buy more stocks for less money as compared to while in a bull market. Also, usually, during a bull market, most stocks tend to be overvalued, but during a correction, the stocks are either fairly valued or undervalued. This helps you buy quality stocks with high growth potential at lower costs.
Identifying quality stocks
This is another very important aspect of a correction. It helps you identify quality stocks. When the overall market sentiment is down, it makes it easier to find a stock that is somewhat resistant to it. Quality stocks generally show limited downside in such cases. Also, even if the stock is declining, the way its management is dealing with the decline can help you pick out a winner. The quality of a manager is best tested during difficult times.
Be greedy when others are fearful
'Be fearful when others are greedy and be greedy when others are fearful is a very popular quote by Warren Buffet. It advises that when everyone is fearful and in panic mode, that is the best opportunity for an investor to accumulate stocks. Market correction and weak investor sentiment give you a scope to buy or accumulate value stocks.
What should you do
While you know now that it is important for investors to stay invested during a correction and even buy more stocks. There are some key things you must keep in mind.
Firstly, before buying any stock you must do proper research of its fundamentals and management. Secondly, you must have patience. Markets always recover from a correction, but it is important for you to have patience and not panic, instead look at it as an opportunity for more.
Also, it is pertinent not to stop and SIPs at this time, instead if you have a lump sum saved, you can buy more units of a mutual fund at lower costs.
While stock market correction is inevitable, so is recovery. A correction gives you a great opportunity to accumulate or buy more stocks at reasonable costs and hence you should take advantage of a correction instead of panicking and withdrawing funds.