A stock market correction could follow the highs of Q3, but strategic preparation may help investors if the markets decline.
Luckily for an out-of-breath toreador, a bull can’t run forever.
After the crash in March 2020, the stock market has steadily recovered during the second and third quarters. In fact, despite the detrimental economic effects of COVID-19, the markets have even hit record highs this year.
But these unusual highs have made some suspicious of its sustainability. Every time the markets dip, some analysts anticipate the start of a market correction. Yet predicting when a market correction might happen, let alone the length and magnitude of the correction, can be an unreliable science.
As with everything else in 2020 so far, the markets can disrupt our expectations. Despite any uncertainty, investors can still prepare for a market correction by establishing a deliberate strategy.
BACK TO NORMAL
While there is no exact number that determines a correction, many define a market correction as a decline of 10 percent or more in stock prices from its most recent peak. A market correction is generally brief, lasting anywhere from a few days to four months.
A drop into bear market territory can feel intimidating, but experts say a correction is the sign of a healthy market. During a market correction, investors may find more affordable buying opportunities, and overvalued prices can adjust to more reasonable levels.
While a market correction can mitigate overinflated markets, it may also lead to panic, overselling, and potentially a longer recession. Considering these factors can help investors take a more practical approach.
LEARN YOUR RISK TOLERANCE
Even when investors have accepted the market decline, seeing prices drop can be overwhelming for some. Understanding your tolerance for risk can help determine how much you want to engage with the markets.
Traders who are reluctant to see the market dip can limit their losses. For example, setting up stop-loss or take-profit orders can help manage risk.
MAKE A TRADING PLAN
A market turn can mean bargain stock prices, but just because the price is lower does not mean the stock is worth buying. Instead, consider which securities are the best for you according to your trading plan. A market turn can happen abruptly, so knowing which stocks are worth a buy can help you make faster decisions.
Those decisions should reflect the research you did on the company’s value rather than what was trending a few months ago. Not all bull markets will perform the same way, since the sectors that took the lead during the last upward momentum may not be the same ones after the next post-bear market recovery. For example, the information technology industry emerged as one of the best-performing sectors in the 2020 recession, though it historically underperforms during recessions.
SPREAD THE WEALTH
No industry is fully recession-proof, and companies that profited during the beginning of the COVID-19 pandemic may not be able to sustain their success through a market correction. Diversifying your assets can limit the potential for high-risk, going-all-in scenarios.
Even the most detailed plan may not be immune to a hit from a market correction, but a mix of investments may help investors endure the decline.
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