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Photo: iStock
Photo: iStock

De-jargoned: Market correction

Technically speaking, a correction is defined as a 10% fall in price of an index or a stock from its 52-week high

The markets are correcting. A correction was due. These are common phrases today. But what is a correction? If the market falls 2% in a day, is that a correction? What if it falls 5% in 10 days? Simply speaking, when asset prices, of say equity or real estate, start to fall after rising over a period of time, it is termed a correction. In case of stock markets, prices of shares are quoted everyday, which means there is a daily change in value. On a daily basis, there could be a fall or a rise. But, a single-day negative change in price is not a correction. An index similarly, which is nothing but a basket of shares, undergoes daily change in value. This is daily volatility rather than a correction. Technically speaking, a correction is defined as a 10% fall in price of an index or a stock from its 52-week high. This can take as many days. For example, in January 2008, the BSE Sensex (Total Return Index - TRI) fell 15% from its then all-time high in a matter of 9 trading sessions. Here we can say clearly that the market was in a correction phase. A TRI captures change in index value from price change and other payouts like dividends. Despite interim upward moves, the correction went on till March 2009, by which time the index had lost slightly over 50% of its value. Contrast this with November 2016, when the markets fell after the demonetization announcement; over a period of one-and-a-half months the index fell around 6.5%, this was not a correction and by January 2017 the markets were on their way up again. For the calendar year 2017, the index was up around 28%. Thus, the magnitude of price fall is important in defining whether the market is in a correction phase or not. In the current downtrend, the index has fallen around 6.5% from its 52-week high, also its all-time high on 29 January 2018, till 22 February 2018. This magnitude shows that the index is not yet in a technical correction phase. However, this downtrend is still not over and it could very well breach the 10% mark. Also, different segments of the market are in varied levels of the downtrend. The BSE Midcap index touched its all-time high on 8 January 2018 and then fell as much as 10.5%. Similarly, BSE Small-cap index touched its all-time high on 15 January 2018 and then fell up to 11.5%. 

Once an index or stock price falls more than 10% from its 52-week high, it is in a correction phase. However, it does not mean that the price will not correct further. How long a correction continues is anybody’s guess. It is prudent to be cautious during corrections but selling and sitting out may not be wise as it is also hard to predict when the market will turn around. A better way is to invest regularly across the market cycle, both in up and down trends. If you do have additional liquidity to invest during a correction phase, invest in small lots rather than putting it in one go.

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