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What is defined as a market correction?

What is defined as a market correction?

Sometimes a stock or index will reflect prices that have become inflated or overvalued in the short-term as a result of bullish conditions. In some cases, due to shift in sentiment or a negative news story in the headlines, stocks may retreat suddenly and without notice.

A market correction is a sharp, sudden decline in stock prices, where they fall in value by around 10% - 20% over a short period, usually no longer than 6 months. Corrections are frequent occurrences (typically an average of once a year) and are a normal and healthy part of equity investing.

While potentially disconcerting, corrections can be good in that they can temper the market and prevent a more catastrophic “bubble” from forming. A bubble forms when investors start bidding up the price of an asset well beyond its intrinsic value, based on speculation and euphoria surrounding potential gains. Demand eventually dries up when valuations are too high, as investors start shunning the risk premium associated with investing. Investors then race to be the first out of the position, which brings all the sellers to the table at once. The bubble then pops.

The 10% - 20% window for a market correction is important: an index decline will typically not be labeled a correction unless prices fall 10% or more, but less than 20% (where the index would enter bear market territory).

Market corrections and bear markets can cause panic and irrational behavior from investors that is detrimental to the health of the market. Investment strategies like portfolio diversification can shield investors from the worst effects of a correction, but opportunities exist for traders to make money even as market corrections take place. Artificial intelligence can identify patterns, or figures on a price chart that reflect the emotional behavior of market participants both bearish and bullish. A.I. can help investors spot opportunities to make advantageous trades regardless of market conditions. By removing emotion from investing, traders can make rational decisions and avoid harmful and costly pile-on scenarios.

Keywords: stocks, investor sentiment, bullish, bear market, stock market correction, bubbles, temper the market, equity investing,
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