In recent news reports and articles, you might have heard the word “stock markets are on a way to correction”. 

Simultaneously you notice drop downs in portfolio values as well. 

If you are a new investor, you might be haunted by the term market correction as people often associate it with panic selling and anticipating bear markets. 

However, it is not the right way to deal with it!

What is a market correction? 

In financial markets, majorly in robust and volatile markets like stock markets, the price change happens quite frequently. 

When the market indices or individual stocks witness a continuous steady increase in the price over a short period, there will always exist a point where it reaches its peak and further, no increase occurs.

After this peak point, the market understands that the asset is overvalued, that is priced above its potential valuation.

Once markets realise this valuation bridge, the peak price starts to fall back. It continues to fall back steadily till it reaches its potential correct value. 

This phenomenon is called a market correction. 

Market correction happens automatically to realise the actual values of indices or individual assets as compared to their inflated values. This phenomenon in technical terms is also known as the “asset price bubble”. 

Market correction occurs for about a 10 % to 20 % drop from the highest peak price. 

Whereas if the drop signifies a bear market, markets will witness a loss of more than 20% fall back prices. 

How to prevent potential losses during the correction?

First of all, being patient during market adjustments is a key to a successful long term portfolio. 

Any number of panic buying or selling will lead to long term opportunity costs and lesser chances of profits.

Here are a few quick pieces of advice to avoid panic and save your pennies from correction signals:-  

• Understand the reasons – The very first step towards mindful investing is to search for reasons for price changes, whether increases or decreases. Knowing why the overvaluation happened in the first place will lead you to predict when and how can the market correction occur.

Then knowing how and why the market correction is occurring you will be able to understand the dynamics better.

Supposing you know the market correction is backed by a neighbourhood war, you now know the economic outlook and impacts on your economy. If the war is predicted to last longer, it is safe to say that timely portfolio adjustments are needed. 

• Cash at hand for dips – once you are clear with circumstances prevailing in the market, you should keep cash handy to invest in dips of the market depending upon short term or long term analysis of market correction. 

The extra cash will add an extra income, whereas if you think to withdraw pennies and then buy the dips, call it off a bad idea if market correction is in sync with your long term goals. 

Remember long term goals require patience and robust risk control appetite with some good backup finances. 

• Diversification – knowing the term is like being an aware investor, but understanding the term will lead you to a successful investor. 

Risk tolerance can be made safer by the means of diversification. Putting your eggs in different baskets will save chances of asymmetric hazards from putting all your eggs in one basket. 

Long term investing with diversification rules out the chances of excess losses during the market correction.

Invest your money in different sectors, businesses, types of models, revenue stocks, growth stocks, etc. rather than piling up stocks of one end of the genre. 

Since not all stocks are of the same nature, when the market corrects some will go down some will remain the same and some might even go up. 

This will keep a good neutral risk balance.  

• Non-correlating items in the portfolio – building a master portfolio that can absorb shocks of markets means accommodating assets of opposite nature.

Such asset combinations can be debt funds and equity stocks. This leads to a balanced long term portfolio with risk and returns. 

Apart from balanced risk and return, the best feature is that they both might move in the opposite direction during market corrections. 

If suppose equity falls, there is a high probability that debt fund returns will rise during the downfall of equity. 

This will rule out the frequencies of panic buying or selling during market corrections. 

• Rebalancing current portfolio plan – long term goals in financial markets need long term portfolios, yet again with so volatile nature of stock markets, one must always keep a check if the portfolio still meets the edges in dynamic scenarios.

If not, then the portfolio should be rebalanced to accommodate all the changes in the market. 

Rebalancing can be a matter of shifting risk from one asset to another or even shifting minor loss-making assets to some gaining stocks. 

The nature of rebalancing is defined by the extent to which the market corrections impact your current portfolio plan. 

• Tax harvesting – knowing tricks where you can save your taxes to maximise gains is the game-changer.

Knowing exactly when to withdraw from the market will save you tax pennies and even balance your portfolio. 

Learn more about Tax Harvesting here

During market corrections, you might witness short leaps of price fall, this will help you sell with a trick to save tax and use the small loss to cancel out tax from gains at end of the year. 

Bottom line 

The intelligent solution never lies in emptying the bottle or adding unlimited water. Before adding stocks one should know the haul of the market and phases of the market correction. 

Whereas no amount of panic selling will help you grow in the market. Patience with the right amount of knowledge will lead you on the path of successful investing and growth. 

Knowing the markets is just like understanding the diseases before treating them with medicine. Right medicine, higher chances of sustaining in the dynamic market.