Home » 8 valuable lessons that can be learned from the past stock market corrections.

8 valuable lessons that can be learned from the past stock market corrections.

8 valuable lessons that can be learned from the past stock market corrections.

Photo courtesy Mediamodifier on Pixabay.

A stock market correction when it is deep always leaves the investors shaken particularly the new ones. The experienced investors have already seen the cycle before and are less perturbed, but the new investors who are investing for the first time often panic and many decide not to return back again after heavy losses. There are always lessons to be learned from the stock market correction.

This time the stock market correction in India in 2022 was due to geopolitical tensions in Europe and disruption in commodity prices due to the rise in Covid-19 cases in China leading to higher inflation. The Indian market was overvalued as compared to the other emerging markets so the FIIs decided to pull out the money. To control inflation the Fed increased the interest rates leading to correction in the US markets and ultimately the world markets; which all follow the US markets. The Nifty hit a high of 18604 in October 2021 and corrected to a low of 16167 in May 2022.

The stock market correction is also known as pullback and happens when there is a decline of 10% or more in the stock market from its 52-week high. During the Bull Run, there is an increase in stock prices which leads to irrational exuberance and the stock prices increase well above their value, and when there is a correction the prices return to their actual value.

A market correction is not a once-a-decade event and happens all the time. The reason for correction may be different each time but they do happen often at regular intervals. It does look bleak when in the eye of a storm but then the markets always recover and continue their upward trajectory.

The lessons that can be learned from stock market correction are-

1) No one can predict the market declines consistently-

There are many analysts on television channels who give their views on the market. Besides this, there are analysts in the financial papers who give their views regularly. But no one is accurate in predicting the market consistently. Did anyone know beforehand that the market would crash in March 2020? Or that it would recover soon after and go on to make new highs the next year.

The future has too many variables that can’t be predicted. Various stock and economic models have gone for a toss when predicting the market as it is no better than flipping a coin and predicting whether it would be heads or tails when the coin will land on the ground. In fact, only two persons can predict the market correctly and consistently; one is God and the other is a liar.

2) No one can predict how long the decline in the market would last-

When there is a correction in the market investors get worried especially the new ones who have not seen it before. They want to know when the bad times would end and they would be able to recoup their losses. Market downturns are common but temporary. No one can predict when the market would rebound but historically the markets have always recovered after the downturn and the recoveries have been sharp.

In the past events like wars, economic crises, and political upheaval have affected the stock markets but it has been temporary. Long-term investors always recover their losses and see the value of their investments go up. Market volatility is uncomfortable only in the short term but people who plan and focus for the long term are always successful and rewarded over a period of time.

3) Investors should sit tight-

Investors are hesitant and cautious at the bottom of the market and confident at the market top and this is the opposite of what is necessary for success. At times of correction, investors should sit tight due to the prevailing uncertainty and stay patient not selling their stock holding at the bottom. Not taking a decision in itself is a big decision. Investors should not succumb to the stress and anxiety during volatile situations in the market and those who are emotionally mature, keep their cool, and are disciplined can achieve success in the long run.

4) Asset Allocation and Diversification-

Many investors want to gain big money during the bull market and they invest all their money in speculative stocks. It is only during the corrective phase they realize how risky their portfolio is when they lose a lot of money. Market corrections always hit some sectors harder than others. Don’t just look at the returns but also at the losses you would be able to stomach without stress.

A diverse portfolio always helps to minimize the risk when the portfolio is allocated across the asset classes, industries, and geographies as it reduces the number of correlated investments. This helps during the market declines. Investing across the asset class be it equity, bonds, fixed income or other alternatives helps in reducing the volatility in the long-term returns.

5) Rupee cost averaging-

There may be market corrections for a few months and then the market would turn around. If you are investing through the equity mutual fund you can keep buying the units through a systematic investment plan (SIP). This averages out the cost and when the market is at a low you get more units. In the rupee cost averaging a person invests a fixed amount at regular intervals irrespective of whether markets are going up or down.

6)  Market panic is a great buying opportunity-

During the market correction, there are many stocks that would have corrected in price and would be available cheaper. It is the correct time to study the fundamentals and invest in the best companies for the long term. When you buy the stocks when there is a sale during the corrections and the bear market you would reap a large profit during the next few years.

7) Learn from great successful investors-

When you listen to the financial media you may lose money as they are trying to sell information that may not benefit you and they may be more worried about their fees. But the best thing would be to read some of the books on the stock markets as this would build up your basics on the investment philosophy which will help you throughout your life. Some of the best books are-

a) One Up on Wall Street by Peter Lynch.

b) Common Stocks and Uncommon Profits by Philip A. Fisher.

c) The Intelligent Investor by Benjamin Graham.

These books have been written by people who have managed large funds and have been successful investors themselves.

8) Avoid illiquid stocks-

Illiquid stocks have very low trading volumes and can be easily manipulated to a higher price. By the time an investor enters a stock, the operators would have already jacked up the price and exited the stock leaving the new investors with the stock they can’t sell.

During the market correction, these stocks fall quickly and those people who enter the stock in the hope of making a quick buck are left holding it without being able to exit at a reasonable price. Though these stocks may be tempting to invest in, the retail investor is always at a disadvantage in purchasing them.

A stock market correction is not always bad and removes irrational exuberance from the markets. Stocks become cheaper in price and it is a good time to invest. An investor can do fundamental analysis and pick great stocks for the long term during these corrections.

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