What to do in a market correction?

For centuries, capital markets have tide over multiple boom and bust cycles. While each market cycle can be attributed to different events in the economy (i.e. Black Monday, Black Friday, dotcom bubble, sub-prime mortgage crisis), there are inherently two emotions that move markets in either direction – FEAR & GREED!

The emotions of market participants have led to some of the greatest market rallies and panic selloffs documented in history. It is not just the emotions of an individual, but the collective emotions of the majority that dictate the direction of the market. On September 29, 2008, the Dow Jones fell a total of 778 points (7 percent), one of the largest fall in a single day. This certainly wasn’t the result of a few sellers looking for a willing buyer, but a large number of panic sellers fearfully throwing their stockholdings at a bargain to any willing buyer.

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Source: imgflip.com

Be reminded that a stock price at any point in time reflects a last transacted price that took place between a willing buyer and seller. This price is known as a “last done” price. Buyers and sellers have to move up their bids (buy) and move down their ask (sell) prices respectively to match the counter-party’s price.

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Source: marottaonmoney.com

I like to believe that the capital markets have a natural stabilizer – when prices increase and overextend beyond “socially expected” levels, sellers would have to reduce prices progressively until they match and transact with buyers at a lower price. This phenomenon is a market correction.

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Source: FactSet

It is only normal for market corrections to happen before a market could advance higher. Much like how winter comes right after autumn every year, markets do not stay in a “season” forever. Historically, bear markets do not last more than two years. The duration of bull markets can vary quite drastically. Currently, we are in our 8th year of the bull market and who knows how much longer and further can this bull run? We don’t know when this market will peak, but we know that this “season” will soon have to end.

The picture will illustrate how the market survived multiple crashes and correction “seasons”, only to recover and make new highs over time. It pays to be patient in the market.

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Source: Business Insider

Economists and financial analysts have been attempting to predict the magnitude of an impending “crash”. With today’s excessive liquidity (read our article How “Printing Money” Changed The Money Game) in the market, there is a possibility that we might only see a correction (10%-20% decline) before we continue making new highs. In any case, a correction could present investors with a great entry opportunity to buy into the market (stocks with good fundamentals or the index). I am a huge proponent of index investing because it is a low-cost and effective way to diversify across different sectors of the market. As Warren Buffett famously said “be fearful when others are greedy and greedy when others are fearful”. It requires a contrarian view from the majority to see an opportunity during times of fear and uncertainty. If you are new to investing, you should read the previous article how to buy your first stock.

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Source: santabanta.com

I hope that this article gives you to the confidence to invest with a long-term perspective and sit through market downturns. Just remember that winter doesn’t last forever – brave the cold long enough and spring would be around the corner!

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Till next week, have a good weekend!

Cheers,

Nigel Fernandez

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