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Wall Street is a complex and ever-changing entity, influenced by many factors such as the Federal Reserve, economic conditions, geopolitical events, and investor sentiment. While stocks can experience long streaks of price appreciation, corrections are a natural part of the market cycle. As the old saying goes, “Without pain, how could we know joy?”
Correcting through Price Versus Time
A correction through price tends to be a dramatic and sudden drop more times than not. The suddenness and velocity can lead to a domino effect, where falling prices cause more selling in what ultimately becomes a “self-fulfilling prophecy” of sorts. In early 2022, this phenomenon gave way to a correction through both price and time.
Image Source: Zacks Investment Research
Conversely, when the stock market corrects through time, it usually means that the price is relatively stable, but the market experiences a brief period of consolidation or sideways price movement. During this time, investors may become hesitant and uncertain, leading to a dry-up in volume and a sideways price chop. Though a correction through time frustrates investors, it can be an essential building block for higher prices later.
Image Source: Zacks Investment Research
Corrections through time are evidence of a more robust market. 2022 was indicative of an equity market that required a large correction or reset. Meanwhile, thus far, the current correction is more a sign of a pause in an uptrend.
Navigating Pullbacks
Market corrections are a normal part of the investing cycle and can often be short-lived. Regardless of whether a correction occurs through time or price, investors need to remain calm and avoid making impulsive, emotional decisions. Below are 3 tips on how to navigate a market correction:
Ask yourself, “What stocks are holding up best?”: Relative strength is the most effective yet simple indicator at an investor’s disposal during a correction. Think of a strong relative strength stock as a beach ball being that is being held underwater. You can only hold the ball down for so long before it springboards back to the surface. Semiconductor leader Rambus ((RMBS - Free Report) ) was a prime example of relative strength in September 2022. In the yellow box on the chart below, notice how RMBS was hitting new highs while the S&P 500 Index was weak and retesting lows. Because 3-4 stocks tend to follow the market direction and RMBS didn’t, the action was noteworthy.
Image Source: Zacks Investment Research
Follow the Leaders: Leaders, or stocks that have been moving up the most in an uptrend are called leaders for a reason – they lead. Presently, tech, specifically semiconductors, are the leading stocks in the market. Innovative chip maker Nvidia ((NVDA - Free Report) ) is among the “cream of the crop” when it comes to true market leaders. As such, regardless of whether or not you caught this year’s breathtaking move in the stock, it bears watching. NVDA is pulling into trendline support and the 21-day moving average for the first time in 2023. If it can hold this zone, the correction may be short-lived. If the stock breaks this zone, the correction likely has longer to go.
Know your timeframe: Before a correction occurs, and before you decide to invest in the stock market, for that matter, you should be acutely aware of what you’re willing to risk and your time frame. In this case, there is no right or wrong answer. However, your time frame should lead you to how you handle corrections. For example, a long-term investor should be able to take a 5-10% correction in the S&P 500 Index in stride. On the other hand, swing traders may need to stop themselves out of some positions in that case and readjust their portfolio. Either way, investors should prepare and have a clear-cut strategy ahead of time.
Conclusion
Price pullbacks are often thought of in a negative light by investors. However, as we explained above, they are a necessary ingredient for the market and can help lead the way for the next market move higher. To succeed, investors should stay calm, informed, and enter corrections with a clear action plan.
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2 Types of Corrections, 3 Ways to Navigate Them
Investors Should Welcome Pullbacks
Wall Street is a complex and ever-changing entity, influenced by many factors such as the Federal Reserve, economic conditions, geopolitical events, and investor sentiment. While stocks can experience long streaks of price appreciation, corrections are a natural part of the market cycle. As the old saying goes, “Without pain, how could we know joy?”
Correcting through Price Versus Time
A correction through price tends to be a dramatic and sudden drop more times than not. The suddenness and velocity can lead to a domino effect, where falling prices cause more selling in what ultimately becomes a “self-fulfilling prophecy” of sorts. In early 2022, this phenomenon gave way to a correction through both price and time.
Image Source: Zacks Investment Research
Conversely, when the stock market corrects through time, it usually means that the price is relatively stable, but the market experiences a brief period of consolidation or sideways price movement. During this time, investors may become hesitant and uncertain, leading to a dry-up in volume and a sideways price chop. Though a correction through time frustrates investors, it can be an essential building block for higher prices later.
Image Source: Zacks Investment Research
Corrections through time are evidence of a more robust market. 2022 was indicative of an equity market that required a large correction or reset. Meanwhile, thus far, the current correction is more a sign of a pause in an uptrend.
Navigating Pullbacks
Market corrections are a normal part of the investing cycle and can often be short-lived. Regardless of whether a correction occurs through time or price, investors need to remain calm and avoid making impulsive, emotional decisions. Below are 3 tips on how to navigate a market correction:
Ask yourself, “What stocks are holding up best?”: Relative strength is the most effective yet simple indicator at an investor’s disposal during a correction. Think of a strong relative strength stock as a beach ball being that is being held underwater. You can only hold the ball down for so long before it springboards back to the surface. Semiconductor leader Rambus ((RMBS - Free Report) ) was a prime example of relative strength in September 2022. In the yellow box on the chart below, notice how RMBS was hitting new highs while the S&P 500 Index was weak and retesting lows. Because 3-4 stocks tend to follow the market direction and RMBS didn’t, the action was noteworthy.
Image Source: Zacks Investment Research
Follow the Leaders: Leaders, or stocks that have been moving up the most in an uptrend are called leaders for a reason – they lead. Presently, tech, specifically semiconductors, are the leading stocks in the market. Innovative chip maker Nvidia ((NVDA - Free Report) ) is among the “cream of the crop” when it comes to true market leaders. As such, regardless of whether or not you caught this year’s breathtaking move in the stock, it bears watching. NVDA is pulling into trendline support and the 21-day moving average for the first time in 2023. If it can hold this zone, the correction may be short-lived. If the stock breaks this zone, the correction likely has longer to go.
Image Source: Zacks Investment Research
Other leading stocks to watch for more evidence include mega-cap tech stocks such as Microsoft ((MSFT - Free Report) ), Meta Platforms ((META - Free Report) ), Alphabet ((GOOGL - Free Report) ), Apple ((AAPL - Free Report) ), Advanced Micro Devices ((AMD - Free Report) ), and Netflix ((NFLX - Free Report) ).
Know your timeframe: Before a correction occurs, and before you decide to invest in the stock market, for that matter, you should be acutely aware of what you’re willing to risk and your time frame. In this case, there is no right or wrong answer. However, your time frame should lead you to how you handle corrections. For example, a long-term investor should be able to take a 5-10% correction in the S&P 500 Index in stride. On the other hand, swing traders may need to stop themselves out of some positions in that case and readjust their portfolio. Either way, investors should prepare and have a clear-cut strategy ahead of time.
Conclusion
Price pullbacks are often thought of in a negative light by investors. However, as we explained above, they are a necessary ingredient for the market and can help lead the way for the next market move higher. To succeed, investors should stay calm, informed, and enter corrections with a clear action plan.