2024 has seen significant growth, especially in the tech sector, but concerns of a stock market correction are on the rise. The Nasdaq Composite index entered correction territory on Aug. 2, closing 10 percent below its recent peak due to a slowing U.S. economy.
Weaker employment and manufacturing numbers triggered a market sell-off, leading to worries about the Federal Reserve’s response in cutting interest rates. Investors are concerned that more significant cuts may be needed to avoid a U.S. recession.
The Nasdaq Composite’s 10 percent decline in August marks its first correction since Jan. 19, 2023, a year that saw the index plummet 36 percent from its high.
What exactly is a stock market correction and how can investors navigate it? Here’s a breakdown:
Understanding Corrections and Their Causes
A correction occurs when an asset drops 10 percent or more from its recent high. For example, a stock that was at $100 per share would be in correction territory if it fell to $90 or below.
Corrections can affect various financial assets, from individual stocks to broad market indexes like the S&P 500. Economic concerns, Federal Reserve policies, political issues, or events like a pandemic can all trigger market corrections, as investors reassess their future expectations and shift towards safer assets like U.S. Treasury bonds.
Distinguishing Corrections from Crashes
While a correction and a crash may sound similar, they differ in the speed and severity of the decline. Crashes involve rapid double-digit percentage drops over a few days, like the infamous Black Monday in 1987. Corrections, on the other hand, unfold more gradually, helping to prevent overheated market conditions by adjusting prices back to more sustainable levels.
Comparing Corrections to Bear Markets
Bear markets signify a decline of at least 20 percent from a recent peak, lasting longer as they reflect broader economic realities like recessions. Distinguishing between a correction and a bear market in real-time poses a challenge for investors.
Investor Strategies During Corrections
For most investors, the best course of action during a correction is often to stay the course. Corrections are normal in long-term investing, and attempting to time the market can be counterproductive. Strategies like dollar-cost averaging and seizing opportunities to invest extra cash during corrections can be beneficial in the long run.
Key Takeaways
While stock market corrections are part of investing, focusing on long-term goals and consistent investment can help navigate through market fluctuations. Volatility is inherent in stocks, emphasizing the importance of aligning investments with long-term objectives.
— This article has been updated with contributions from Rachel Christian.