The markets had been on an impressive bull run for two years. However, the S&P 500 entered market correction territory during the first quarter of 2022. Dips like this can be alarming. With market corrections come fears of market crashes or long bear markets looming ahead.
Unfortunately, these bear markets are ripe for making massive investing mistakes. Here are five common mistakes investors make during market correction and how to avoid them.
What Is a Stock Market Correction?
A stock market correction is simply defined as when the market drops at least ten percent from its most recent high.When the market begins to drop above twenty percent, this no longer indicates a market correction but rather the beginning of a bear market.
Overall, stock market corrections are a straightforward concept as it simply refers to a ten to twenty percent drop compared to the recent highs of the market.
Generally, a stock market correction happens after a bull market has had a steady run and has gotten ahead of itself. Market corrections are nothing new and, if viewed purely through a rational lens, should never be feared as market corrections generally occur once per year on average.
Sometimes corrections spawn crashes, and that potential is what sparks fear. For example, in March 2020, the market experienced a sudden drop of more than thirty percent. While this had many investors alarmed as a market correction was coupled with the COVID-19 outbreak, the market quickly bounced back and reached new heights. In large part that was due to the Federal Reserve’s highly accommodative stance.
For investors who remained calm during the 2020 market correction, huge gains were on offer. By continuing to invest in the market and maintain their holdings, these investors were rewarded significantly. Unfortunately, investors that fell into the trap of making knee-jerk investment decisions based on the floundering economy, the big market drops, and less than encouraging new headlines lost significant funds and missed out on handsome gains.
Market corrections will always occur. How your portfolio weathers these corrections will largely depend on your decision-making process and overall response to the ups and downs of the market. To avoid making massive mistakes and losing out on huge gains for your investment portfolio, here are some steps to take.
5 Massive Mistakes To Avoid In Market Correction
The most recent market correction is not really unexpected when looking at the record-high stock market valuation, a global pandemic still running its course, high inflation, and overall economic uncertainty tied to the threat of another world war following the Russian invasion of Ukraine.
With all the uncertainty that remains regarding the overall economy, it is essential for your investment portfolio to avoid the common mistakes that many investors make during market corrections.
1. Ignoring Stop Losses
One common mistake that investors make during market corrections is ignoring stop losses.
A stop-loss order is simply an order that is placed with a broker to buy or sell a stock when it hits a certain price. Stop-loss orders are used to help limit an investor’s loss when a stock drops suddenly and significantly.
To mitigate risk and overall loss during market corrections, it’s important to have stop-loss orders in place. Whether you’re looking to make long-term or short-term investments, implementing the stop-loss tool can benefit your investment strategy.
2. Investing Too Heavily Into Risky Stocks
Another common mistake many investors make during market corrections is going all-in on risky stocks.
While rewards require risk, investing too heavily into risky stocks with the hope that these risky stocks will recover is not a great investment strategy.
Instead, it’s always best to have a long-term vision when it comes to investing and balance your investments between blue-chip stocks and potential growth stocks.
3. Panic Selling
While market corrections can certainly induce a fair amount of worry, it’s essential to take emotion out of investing to avoid panic selling during times of certainty. Panic selling is one of the worst and most common mistakes investors make during market corrections.
Overall, during market corrections, it is important to remember that the stock market is cyclical in nature and that prices will recover over time.
4. Trying To Time the Market
While many investors try to time the market, this strategy does not generally prove successful, especially during times of market corrections.
According to Fidelity, the cost of poor market timing can end up costing investors hundreds of thousands of dollars over the course of their investing careers.
While the goal is to always buy low and sell high, no investor has a crystal ball letting them know when’s the perfect time to enter or leave the market. Overall, time in the market will always be better than timing the market.
5. Selling Safe Stock Holdings
A final common mistake that many investors make during market corrections is selling off safe stock holdings in favor of chasing risky returns from volatile stocks.
Chasing performance has proven to be a dangerous investment strategy. For example, the rise in meme stocks like AMC Entertainment in 2021 allowed some investors to collect considerable gains while others suffered significant losses.
AMC stock rose from around $2 per share in January 2021 to over $70 per share in June 2021, all thanks to internet memes.
While some investors jumped in when the stock was at its all-time high in fear of missing out on future gains, they ended up losing, with AMC stock dropping to only $15 per share in March 2022.
Certainly, some investors were lucky and made significant gains with their AMC stock, chasing performance on risky stocks does not generally pay off in the long run as you have to assume that other investors will continue to push the price higher without any evidence backing that assumption.
How To Invest During a Market Correction
Along with avoiding the five common investing mistakes outlined above, the best strategy to implement during a market correction is to keep a diversified investment portfolio.
While it may be tempting, avoid selling off your safer stock holdings in favor of chasing gains through risky stock picks. Investing in some riskier stock picks is not bad, but you should never go all-in to risky investments.
Overall, keeping a diversified portfolio is really the key to surviving market corrections. Through diversification, your holdings will be spread across a variety of sectors allowing you to be better protected during times of high volatility. Finally, during times of uncertainty, always keep in mind that the market has historically recovered time and time again.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.