What Is a Stock Market Correction?
Here's what happens when the market declines, why it does so and how long a drop may last.
Many, or all, of the products featured on this page are from our advertising partners who compensate us when you take certain actions on our website or click to take an action on their website. However, this does not influence our evaluations. Our opinions are our own. Here is a list of our partners and here's how we make money.
The investing information provided on this page is for educational purposes only. NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments.
A stock market correction is a fall in value of at least 10% (but less than 20%) from a recent stock market high. People often use the term "correction" describe a drop in the market as a whole or within a specific index, such as the S&P 500. Individual stocks can experience a correction, and usually with much more volatility.
Correction vs. crash vs. dip vs. bear market
A dip is a brief downturn from a sustained longer-term uptrend. For example, the market may go up 5%, linger, and come down 2% over a few days or weeks.
A crash is a sudden and very sharp drop in stock prices, often on a single day or week. Sometimes a market crash foretells economic malaise, such as the 1929 crash when the market lost 48% in less than two months, kicking off the Great Depression. But that’s not always the case. In October 1987 stocks plunged 23% in a single day before roaring back over the next year. Crashes are rare.
A bear market is a long, sustained decline of at least 20% from the market’s most recent high.
Why stock market corrections happen
At the most basic level, market corrections occur because investors are more motivated to sell than to buy.
That’s simple supply and demand, but it doesn’t explain why investors are selling.
Investors are a forward-looking bunch. They’re trying to determine whether their investments will appreciate in value. Investors watch for signs, including news, rumors and anything in between, of how the market will move. It moves for many reasons, including because the economy is actually weakening, or based on investors’ perceptions or emotions, such as the fear of loss, for example.
The reasons for a one-day drop may vary, but a longer-term decline is usually caused by one or several of the following reasons:
A slowing or shrinking economy: This is a fundamental reason for the market to decline. If the economy is slowing or entering a recession, or investors are expecting it to slow, companies will earn less, so investors bid down their stocks.
Lack of optimism: This refers to the surges of investor emotion and risk-taking during a bull market. As they see the chance for profits, people jump into the market, pushing stock prices up. When that optimism dries up, investors may be inclined to sell.
Fear: If investors think the market is going to fall, they’ll quit buying, and sellers will have to lower their prices to find takers.
Outside (and outsized) events: This miscellaneous category includes everything else that might spook the market, such as wars, attacks, oil-supply shocks and other events that aren’t purely economic.
These reasons often work together. For example, if the economy is overheating, some investors may see a slowdown in the future and want to sell before a stampede of investors flees the market. So they sell, pushing stocks lower. If the move down persists long enough, investors may become fearful, sending stocks still lower.
How long do stock market corrections last?
Historically, corrections generally last around four months on average.
Knowing exactly how long a correction will last is a billion-dollar question. If you knew that, you could time the stock market and become rich.
What happens to your portfolio in a correction?
The Dow Jones Industrial Average ("the Dow") and the S&P 500 index are the usual benchmarks investors reference when they talk about “the market.” But unless you’re invested exclusively in a broad index fund such as an S&P 500 index fund, your actual returns will differ from the market’s returns.
It’s important to understand that if a stock’s price declines by 30%, you’ll need an increase of more than 30% to recoup your losses. For example, if your $100 stock declines by 30% to $70, the stock will need to rise nearly 43% from that $70 price to get back to $100.
What happens to your portfolio during a stock market correction depends on the asset allocation and diversification in your portfolio. Stocks tend to be more volatile than bonds or many other financial instruments the market.
» MORE: How taxes on stocks work
How can you prepare for a correction?
There isn't a foolproof way to be completely prepared for a stock market correction, but these things can help mitigate the impact of one.
Diversify your portfolio. Diversification is an investing strategy in which the investor spreads investments across different types of asset classes in order to reduce the risk of loss. Because different asset classes react in different ways to market changes, diversification helps reduce the chance that one market event or one investment’s poor performance will decimate the portfolio.
Know what your long-term investing strategy is. Establishing clear financial goals can help you ride out market volatility and stay clear-headed when everyone else is panicking. A good financial advisor can help you set these goals and be a sounding board when you have the urge to make sudden changes in your porfolio.
