The nasdaq index of large technology firms ended Wednesday more than 10% below its record high in November and confirmed what is known in the market as a correction. With the closing on Friday, of 13,768 points, it accumulates a loss of more than 15 percent.
A correction in the financial markets is an undesirable situation, of course, because the prices of an asset or an index fall more than 10% from their record high. They can be caused by the end of a phase of euphoria or by changes in the positive conditions that were pushing the price.
In both cases, investors assess the situation, rearrange their portfolios and position themselves in a way that best responds to the new reality. This often leads to sharp profit-taking declines, while increasing volatility in a market undecided about its next steps.
No one wants to get caught up in a market correction phase, especially because of the possibility that the decline reaches 20% and turns into a bear market. That is why the books recommend trying to understand what causes the movements to respond in a logical and never visceral way.
understand the correction
The fall of the Nasdaq is caused by imminent increases in the interest rates of the Federal Reserve and it grows ahead of the first meeting of the central bank in 2022, which will take place next week. Investors brace themselves for information that the market might not like.
Some investors like the famous Warren Buffett They believe that equity markets fall when rates rise, mainly because they indirectly compete to provide better risk and reward. Without risk, bonds would be more attractive when stocks fall.
Big tech and growth firms, whose valuations are set according to future earnings criteria, were among the biggest beneficiaries of strong pandemic-era stimulus to the economy. The withdrawal of these supports is another fundamental reason for this correction.
On the other hand, the advances of some of the big technology companies could be considered exaggerated, without the stimuli that accelerated their growth. Microsoft Corp, one of the best examples, raised its capitalization by more than 50% in 2021 and could hardly justify itself.
What to do in a correction?
The most important thing for an investor is to constantly evaluate the situation to anticipate these types of movements, but it is easy to detect them only when they are already a reality. For the less experienced or knowledgeable, it is best to remain calm; selling might not be the solution.
“At this time it is not recommended to sell shares. This situation is something that did not start now, it comes from about four weeks ago due to the low production of goods, jobs, low consumption and rates,” said Jorge S. Soto, Master in Finance from the Universidad del Valle de México.
For this trader, the most important thing is to think about what type of stock was invested in and not to trade based on its prices. “Investing in Peloton is not the same as investing in Microsoft, that’s why you have to read quarterly reports. For small investors it is better to buy baskets of securities”.
It is also necessary to understand that the corrections are, at least so far, temporary movements and that they occur quite regularly. In a period such as 2000-2021, 16 corrections were presented in the S&P 500 and only three resulted in a market classified as bearish.
“The decision and the opportunity are there at all times, but that is why the investment is for the medium or long term. Corrections are the most normal in the markets. They give movement. Those who are able to keep their losses without selling are the ones who will have an extra profit”, he said.
Inaction may be the best action in these cases. A popular belief in the United States is that when attacked by a bear, it is best to play dead. And in stocks, when bearish bears drive prices down, it may also be best to hold on and wait.