Market correction, explained: What it is and what triggers it
A decline in prices isn’t necessarily a sign of a full-blown market crisis. Learn what a market correction is, what causes it, and how to spot the difference between a correction and a crash.
6 min read
Sudden drops in stock prices can be unsettling, especially for newer investors. But not every decline means that there’s a full-blown crisis coming on. It could be a market correction — and that’s a natural part of the economic cycle. While it may seem alarming, a stock market correction can come with opportunities for long-term investing.Understanding why the stock market falls, how it recovers, and what drives these changes is part of what you need to know when investing. Here’s what market corrections are, their causes, and how investors can spot when one is happening.
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A market correction refers to a temporary decline in asset prices, typically after a period of rapid growth. It’s most commonly associated with the stock market, but corrections can also occur in other sectors like the crypto market, real estate, and even commodities like gas and oil. In each case, a correction helps adjust prices to reflect the asset’s true market value. This stabilizes assets that may have been overpriced, which helps to rein in speculation and avoid potential bubbles.
Typical percentage declines during a market correction
A stock market correction is generally defined as a decline of 10% or more from a recent high. Unlike a stock market crash, which is more severe and sudden, corrections tend to be gradual, and they can be followed by a period of market recovery. In the crypto market, corrections can be more volatile, with percentage swings well into the double digits.Understanding these declines is key to navigating the ups and downs of the market — without getting overwhelmed by investment anxiety. Let’s look at the main characteristics of a market correction and what investors watch for.
Market correction characteristics
A market correction can last from a few weeks to several months, depending on economic conditions and investor sentiment. Unlike a prolonged stock market decline, which can be a sign of a recession, corrections are temporary and help balance overvalued prices after periods of really fast growth.
What triggers a stock market correction?
Several factors can cause a correction across different markets, including:
Rising interest rates: Higher borrowing costs can slow economic growth and affect stock valuations.
Economic uncertainty: Concerns about inflation, recessions, or a slowdown in GDP growth can cause investors to be more cautious.
Changes in investor confidence: Market sentiment plays a key role, and fear-driven sell-offs can accelerate a downturn.
Geopolitical events: Global conflicts, trade disputes, or unexpected policy changes can create market instability.
High volatility: Digital assets like cryptocurrencies often have larger price swings due to speculation and regulatory concerns.
These corrections are a normal part of investing and can pave the way for future market recovery.
Historical examples of corrections in different markets
Historically, stock corrections have been a regular part of the cycle of the stock market. For example, the S&P 500 went through a correction in early 2018 because of concerns over inflation and rising interest rates. More recently, the 2022 stock market correction was driven by tightening monetary policies and uncertainty in the global economy. Outside of stocks, market corrections also impact commodities and real estate. The oil market, for instance, had a sharp decline in 2020 during the global pandemic, when demand for oil dropped significantly. Cryptocurrency is particularly known for being prone to corrections. For example, alongside its rapid rises in prices, Bitcoin has also had periodic price drops of 25%, 50%, and even 80% over the last 10 years. Intuitively, we might think that a drop in stock market prices is cause for concern. But again, corrections like these are often a sign of a healthy market readjusting. So, what exactly causes market corrections?
Why do market corrections happen?
Market corrections happen for various reasons. Often, they’re driven by larger economic shifts or sudden market disruptions. Some of the most common causes are:
Economic factors: Rising inflation and increasing interest rates can reduce corporate profits and investor confidence, leading to a market correction.
Political events: Elections, policy changes, and trade disputes can create uncertainty and market fluctuations.
Market sentiment: Fear or speculation can trigger sell-offs, especially in highly reactive sectors like tech stocks or the crypto market.
However, not all market corrections follow the same pattern. Different asset classes are more sensitive to certain factors. Plus, the speed and size of the correction can vary depending on the type of market. For example:
Stock market corrections are usually gradual, often triggered by economic shifts or earnings reports that fell short of expectations.
Commodity market corrections: Oil, gas, and metal prices can fluctuate sharply if there are supply and demand imbalances or geopolitical tensions.
Crypto market corrections: Percentage declines in the double digits are common in crypto, due to speculation, regulation changes, and market liquidity.
That’s the “why” — how about the “what”? Let’s go over the actual effects of a stock market correction and how they impact different types of investors.
What's the impact of a market correction?
A market correction can have both short- and long-term consequences for investors and the broader economy. For some, it can be scary to see the market going through a downturn. Investors might react by selling off their assets in a panic, or by hesitating to make new investments. There are powerful behavioral biases going on, too, such as loss aversion. This can cause investors to make emotional decisions rather than strategic ones. We may know rationally that corrections are normal, but they can still impact consumer confidence, corporate earnings, and economic growth. If the stock market declines for a longer period of time, investment and spending could continue to slow down as well, which affects job markets and business expansion. Although there’s often volatility in the short term, nothing lasts forever — and that’s certainly true in the stock market. Over time, markets tend to stabilize and regain the value they lost, especially when economic fundamentals are still strong.
How to recognize a market correction
For all investors, it’s useful to be familiar with the indicators of a market correction. A little knowledge goes a long way to helping people stay calm and make smart, well-informed decisions. Here are some places to check for signs of a market correction:
Stock indices: A sudden decline of 10% or more in major stock indexes like the S&P 500 or Nasdaq often means that a correction is happening.
Volatility index: A spike in the volatility index (VIX), often called the "fear index," suggests that investor uncertainty is on the rise.
Earnings reports: If multiple companies report that their earnings were weaker than expected, it may be a sign of broader economic challenges.
Analysts’ forecasts: Financial analysts and institutional investors often adjust their forecasts based on economic data, which can be an early warning of a downturn.
Once more for good measure: A market correction is a natural part of investing. It’s important for the health of the market, since it stabilizes overvalued assets and prevents unsustainable growth. These periods can be challenging, but they're typically temporary and can be followed by a market recovery. When investors know why a stock market correction happens and how to spot one, they’re in a better position to handle the uncertainty. Ultimately, it’s about being empowered to make smart, strategic financial decisions for the long run.
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FAQs
A market correction is a temporary decline of 10% or more. A market crash is a sudden and more severe drop, often more than 20%, and it’s usually driven by panic selling.
Historically, corrections in the stock market happen once every one to two years, although it depends on economic conditions and market cycles.
There are some typical warning signs, like rising volatility or declining earnings. But it’s really difficult to predict the exact timing of a market correction, as investor sentiment and external events are major factors.
Sectors with high valuations and high volatility — such as technology, cryptocurrency, and growth stocks — tend to have sharper declines during stock market corrections.
Yes, market corrections help prevent asset bubbles, create buying opportunities for investors, and allow markets to stabilize at more sustainable price levels.
