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How to safely steer through a stock market correction

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By John Beveridge - 
How to safely steer through stock market correction

Navigating a share market correction is something that eventually comes to all share market investors.

No matter how many you may have survived, there are always the same pitfalls and temptations to resist.

One thing that always seems to surprise is how fast the market can fall.

One minute you are cruising along and everything seems stable and the next your shares have lost 10% of their value or more.

Gains that were amassed over six months or a year or more are literally gone in the blink of an eye as the old saying about the market going up the stairs and down the elevator once again proves correct.

So, what are some of the big traps that you should avoid at all costs?

Don’t join the rush for the exits

The first and most obvious is not to join the panicked rush for the exits, except for some particular circumstances such as meeting margin calls on leveraged positions.

Selling into the teeth of a falling market may feel like “taking action” but the result is inevitably to turn a potential loss (or reduced profit) into an actual loss.

Even if you know intellectually that trying to time the market is a mug’s game, the temptation to get spooked and sell is always real.

The old Warren Buffett quote – “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes” – is a great one to remember when you are surveying the damage caused by the correction.

Concentrating on the quality and long-term soundness of the shares in your portfolio is a great way to resist the siren calls to sell and end the pain of losses – which are always more keenly felt than profits.

The one exception to this rule is to rid your portfolio of any highly speculative stocks that you are now not confident of holding into the future.

Resist the temptation to overdo the bargain hunting

Another common reaction to a snap correction is to go on a spending spree.

While investing in a contrarian fashion is a sound strategy, rushing into it without much thought and a sense of bravado can be just as bad as panic selling.

As we have already noted, market falls tend to be faster than rises so there is plenty of time to set up and plan purchases.

Often a correction also represents a turning point that changes things and this one is no exception.

Growth stocks and particularly technology companies have led the market down which is fairly logical given investors are now worried about rising interest rates.

That means that stable and well-run value companies with strong dividends and cash flows could be worth considering ahead of companies that are relying on future growth for financial returns.

Higher interest rates and inflation will change the investment game a little so this is a great time to plan a long-term buying strategy rather than hitting the buy orders too fast and indiscriminately.

Beware of volatility

One of the features of all corrections – and this one is no exception – is that volatility can be extreme.

That has been apparent this time as well with massive turnarounds within a single day with markets scoring solid gains in morning trade, only to be followed by crunching losses in the afternoon.

With markets moving up and down by up to 4% in a single day, that produces some very choppy trading which is quite different to the environment in a steadily rising but reasonably stable market.

Now is not the time to simply place an at limit order and leave it in place without monitoring market moves.

There are likely to be some fast and furious movements in both directions from here on in so it is essential to re-program yourself to the current conditions and take the opportunity to slowly and carefully stock up on some cheaper stocks in an environment that is very different to the last year.

Remain flexible

It is really important after a correction not to get stuck with a particular view and to remain flexible and open to new ideas as circumstances reveal themselves.

Just to go through a few examples, will the current bout of excess inflation turn out to be a result of the unique strains on the supply chain brought on by the fight against COVID-19 or will it develop into something much harder to fight against which will require continually raising interest rates?

Despite the signalling by the US Federal Reserve, how fast will their tapering of bond purchases be and how quickly and how far will they raise interest rates to catch up with the inflation curve?

How will the world economy stand up and will the current situation of low unemployment and reasonably robust economic growth hold up or will growth slow or even turn into a recession?

And the really imponderable question, how will the COVID-19 pandemic evolve from here on?

Nobody knows the answers to these and other important questions, so continuing to monitor what is happening in the world and particularly in the world’s biggest market – Wall Street – is going to be essential.

Enjoy the slump

While it might seem counter-intuitive, it is a great idea to embrace and welcome the correction and whatever comes after it.

While everybody would prefer that markets kept gently rising in a straight line, that is not what happens in the real world and a correction is a really healthy thing for the market over time.

Market falls are actually important opportunities that need to be grasped and can produce some of the best chances of producing outsized returns in the long term.

To check out the veracity of that claim you don’t need to look any further back than the savage correction that happened back in March 2020 when the ASX 200 slumped from above 7000 points all the way down to a more than 30% drop to 4816 points as investors finally realised that COVID-19 was going to cause massive global economic fallout.

That would have felt like a terrible time to buy shares as gloom became the predominant mood but in retrospect anyone who did would still be sitting very pretty now, even as we enter another correction.

A correction is a terrible crisis to waste but by keeping alert and playing the long game, coming out a winner on the other side is not only possible but highly likely.