A market correction in the financial market is when there is a pullback in stock prices, and it can be regional or global in nature. Typically, a correction is represented by a short-term drop in market prices that might be attributed to extraneous circumstances unrelated to underlying financial conditions of a stock. During a correction, stocks typically lose 5 percent to 20 percent of their value in a matter of weeks or months. There is no one way for investors to play a market correction correctly, although there are certain strategies that could work if the investor is in a financial position to make changes.
During a market correction, most all stocks lose value, ranging from poor-performing securities to industry leaders that have otherwise stood the test of time. Because both groups can be battered during a short-term drop, one way to play the markets is to sell some of the weaker names in a portfolio, stocks that were not stellar performers even prior to any correction. In addition to lackluster performers, a market correction might also be a good time to unload stocks that are risky. A pullback in the financial markets is a good time to evaluate one's risk/reward profile, and a market correction serves as a reminder that risky investments can be damaging to a portfolio during certain cycles.
Because high-quality stocks are most likely trading at a discount during a downward market trend, investors can use this opportunity to buy expensive stocks while they are on sale. Profits generated from selling weak or risky investments might be redirected to high-quality securities. As long as the economic fundamentals of a company are strong, including sales and profits, a stock might be unduly punished during a market correction. This is because either fear or some other short-term event is driving buying and selling activity, but once the dust settles, a solid company is most likely in position to rebound. By investing during a downturn, investors are in place to reap forthcoming profits.
Investors might opt to exit the stock market when market prices become depressed. Instead of investing in stocks, they might flock to safer asset classes, such as bonds, which pay a fixed income amount to investors over a period of time. This is a fine way to play the markets as long as bonds are yielding respectable returns. If, for instance, the interest rates on bonds are equivalent or below what a savings account is yielding, there is little incentive to transfer risk from stocks to bonds.
