Tomayto, tomahto. For many investors, the difference between a market crash and a correction is very little, as both mean nerve-wracking drops in your portfolio. But understanding the technicalities might help take some sting off inevitable stock slumps and prepare you for what might come next.
Okay, so what’s a correction?
It’s when a major index, such as the Dow Jones industrial average (or “Dow,” which includes 30 of the biggest U.S. stocks), or Standard & Poor’s 500-stock index, falls at least 10 percent below its recent high. Corrections are a totally normal part of the stock market cycle, typically occurring every one to two years—the most recent one happened in early February. You can think of them as breathers bull markets need to take before continuing to run.
And crashes are?
Not quite so natural and far more loosely defined. The term “crash” more generally applies to any significant drop in the market, and they typically occur pretty suddenly. Think: the May 2010 “Flash Crash,” when the Dow plummeted more than 1,000 points in just 10 minutes before recovering most of those losses by the closing bell. Or Oct. 19, 1987, ominously known as “Black Monday,” when the Dow plunged a record 22.6 percent.
What causes each?
Corrections come on as a reaction to investors’ “irrational exuberance,” an investing term that refers to how people can get too enthused over an investment (or the stock market at large) for no good reason and push up buying.
Crashes are the opposite, in a way. They’re typically caused by panic selling, with investors watching others offload shares and follow suit without really knowing why.
What does this all mean for me?
Whether it’s a crash or a correction, pullbacks in the market aren’t unusual, so mentally prepare yourself for them. That means having a long-term investing strategy and a well-diversified portfolio that can ride out the inevitable declines and serve you when the market’s up.
Investing on a regular schedule can also help you take advantage of market fluctuations, allowing you to buy more shares when prices are low and fewer when prices are high.