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What Is A Correction?

Correction is a term used in the financial market to describe a pullback in the price of a security after its recently achieved peak. To put it simply, it refers to the decline of security’s worth after an excessive increase.

Deeper Definition

Correction is a phenomenon in the financial market where the price of an asset that has been on the rise swiftly reverses and declines. It can happen to individual assets, such as a company’s stock, or it can happen to a market in general, such as the cryptocurrency market. Essentially, it returns the price from an abnormal increase to an acceptable range.

A correction is a short-term drop in a security’s performance and is less severe than a crash. While there is no strict or set standard for what percentage decline constitutes a correction, it is generally agreed that price must drop by at least 10% from its recent peak. After a price correction, the market or asset usually recovers. However, in some cases, it could see a prolonged decline known as a bear market where prices drop by 20% or more.

Investors, traders, and analysts can use charts and technical analysis to predict corrections before they occur or track their progress. Corrections may last for days, weeks, or months before the market or asset resumes its upward movement, and no one can accurately predict how long it will last or how drastic the price drop will be. As a result, inexperienced traders or investors may panic and sell their positions during the period, seeing the sustained price decline. On the other hand, experienced traders or investors may seize the opportunity to accumulate more assets at a lower price, hoping to sell them when the price recovers.

There are various reasons why corrections happen in a market, and it is often difficult to pinpoint. The following are some possible reasons why they occur:

Short-term investors taking profit

Analysts air opinions that the market is “overvalued.”

Margin traders liquidating their positions

News about upcoming government regulations

Correction Example

Corrections occur in various financial markets and can be frequent depending on how volatile the market is. For instance, the cryptocurrency market is volatile. In 2021, the market experienced four corrections. A correction is essentially a price drop, usually 10% or more, after an asset reaches a recent high. For instance, the price of Bitcoin reached an all-time high of $66,000, and after some days, the price dropped to $58,000.

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