How to Prepare for a Market Correction

A market correction, which occurs when the stock market falls abruptly, can seem like an investor’s worst nightmare. And while declines can actually be healthy, allowing markets to rebalance and adjust, that knowledge can come as cold comfort to investors when it comes to the thought of losing money on their investments.

Investors can overcome this inconvenience by knowing how to: prepare for a recession in the markets, even if it is unexpected.

Diversification between different stocks and asset classes can somewhat protect an investment portfolio from a market correction. But in this changing and volatile market environment, how can investors know which stocks will position their investment portfolios well?

What about other asset classes such as: cryptocurrency? Here’s what you need to know about how to approach investments during a market correction:

— What is a market correction?

— How to treat stocks in a correction.

— Stock technical analysis.

— How to think about cryptocurrencies during a downturn.

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What is a market correction?

A market correction occurs when the stock market falls sharply. More specifically, a 10% drop in a broad measure of stocks from their highs within a short period of time. Market corrections are abrupt and can happen without warning.

Corrections are common after a period of positive market performance. Throughout 2021, investor optimism, along with the Federal Reserves accommodative monetary policy has led markets to record highs. Investors have piled into the markets, taking profits during the bull market and resulting in more money in the markets, a cycle that could lead to overvaluation.

When investors see an opportunity to sell their overvalued stocks for a profit, this trend could accelerate across all markets and trigger a massive sell-off, leading to a correction.

[READ: Are Stocks, Real Estate and Bonds in Asset Bubbles?]

How to handle stocks in a market correction?

If your portfolio is heavily allocated to: shares, you may be wondering what the best rate is when a market correction is imminent. Having a portfolio well-balanced between stocks, bonds and other risk-tolerant asset classes can be a winning strategy, experts say.

As equities have performed well over the past decade, investors need to “reverse equity exposure and make sure they have a healthier weighting on bonds” to protect against a downturn in equities, said Donald Calcagni, chief investment officer at Mercer Advisors in Deventer.

He adds: “Within equities, investors should rebalance their portfolios toward value stocks.”

As the economy struggles to emerge from the coronavirus pandemic and interest rates rise, value stocks may outperform growth stocks.

These growth stocks, such as Facebook Inc. (ticker: FB), Amazon.com Inc. ( AMZN) and Alphabet Inc. ( GOOG, GOOGL), have had a great run over the course of the pandemic. Investors in Invesco’s QQQ Trust ETF ( QQQ), which owns Facebook, Alphabet, and Amazon.com along with other big tech names, has seen it rise about 100% since the darkest days of the pandemic.

Now may be the time for investors to pocket some of their profits and rebalance them toward a value mutual fund or exchange-traded fund, Calcagni says.

He lists three reasons why shedding growth names may be the right choice.

First, the valuations are sky high. “If you don’t sell shares now, when will you?” asks Calcagni. The S&P 500’s P/E ratio is near 35, higher by historical standards.

Second, Calcagni says, there are opportunities in the market, such as value games or… non-US stocks, that offer better deals than US growth stocks. “Non-US stocks look very attractive on a valuation basis compared to US equities,” Calcagni said. “At least 30% of the equity portfolio (of investors) must be non-US equities.”

Third, capital gains taxes are expected to be higher in the future.

“It makes sense to hold (to resell) lower capital gains rates today rather than hold a stock and sell it (in) the future at a much higher capital gains rate,” Calcagni says.

[SEE: 7 Best Financial ETFs to Buy Now.]

Do your stock technical analysis

Assessing the technical aspects of a stock can provide useful insights into how the stock performed in comparable market conditions and what investors can expect as they look ahead.

Technical analysis involves reviewing historical stock performance data and volume as a way of predicting the direction of a stock’s price. Technical analysis can help investors identify overvalued stocks and exit their positions before a market correction.

Indicators such as price differentials, volume shelves and moving averages can provide clues to the future, said Jake Wujastyk, chief market analyst at TrendSpider, a technical analysis software company.

“Look at the charts and historical price action to get an idea of ​​what the average past decline was, based on various technical conditions,” Wujastyk says.

This kind of careful preparation can help savvy investors weather a correction. In fact, long-term investors should welcome corrections, Wujastyk says.

This is a time “to average the dollar cost in positions they currently hold and/or to find stocks they’ve looked to take positions in,” Wujastyk says. Dollar Cost Averaging is a technique in which investors allocate money to an investment at regular intervals over time. This method can attenuate the effect of volatility.

[Read: How Blockchain Can Transform the Financial Services Industry.]

What about cryptocurrencies?

When an asset falls by more than 10%, it is considered a correction and investors may be concerned about a possible crash.

This drop could also shake up crypto markets. But investors need to have perspective: for cryptocurrencies such as: Bitcoin, a 10% drop is just another day in the markets.

The crypto market is more sensitive to global events because: cryptocurrency are a fledgling asset class, the target of speculation, continue to be supported by an evolving technology and are still a relatively new concept to investors.

Investors shouldn’t necessarily see the crypto market’s peaks and troughs as syncopated with the stock markets.

While corrections tend to reverberate across the markets, finding that correlation with the crypto markets is difficult, said Chris Kline, founder and chief operating officer of Bitcoin IRA, a cryptocurrency retirement platform based in Los Angeles.

Since cryptocurrencies have only been around for a short period of time, there hasn’t been enough time to see how they perform in stock market corrections.

There is a big difference between a Bitcoin crash and a stock market correction: the speed at which cryptocurrencies recover from a downturn compared to stocks. Cryptocurrencies have recovered faster than stocks in the past.

“If you look back at what happened in March 2020 and which assets moved faster in recovery, crypto was headed that way,” says Kline.

Crypto investors may be used to volatility. But with the stock market sell-off earlier in September and the most recent 10% drop in Bitcoin, everyone may be concerned, especially those who have part of their retirement in Bitcoin.

But as with stocks, investors can prepare for significant declines in the crypto market. Some crypto investors use it as a nest egg and have a long-term investment mindset, with a timeline of at least three to five years, rather than jumping in and out of the markets, Kline says.

“If you start with the end in mind, you’ll get a better outcome based on your expectations,” he says.

During dips in cryptocurrencies, Kline says, you tend to see an “accumulation trend,” where investors see dips in crypto prices as buying opportunities, be it Bitcoin or alternative currencies.

Take

It can be stressful to think about how a market correction could cause you to lose money on your investments. But knowing that market declines are a temporary feature of the stock market, you can prepare for such an event. It may not be an insurmountable challenge to weather a temporary market downturn, especially with a long-term investment plan.