Market Corrections vs Crashes: What Is the Difference
Not every red day in the market is a crisis. Investors categorize market declines by the severity of the drop from a recent high. Knowing these labels helps you keep things in perspective when the news starts screaming about an impending collapse.
- Dip: A minor decline of less than 10% [8]. These happen frequently and are often considered market "noise" [8].
- Correction: A decline of 10% to 19% [2], [5]. These occur approximately every 1–2 years [10] and are considered a "healthy" way for the market to reset valuations after a period of over-optimism [3], [5].
- Bear Market/Crash: A decline of 20% or more [2], [8]. These are rarer and often coincide with significant economic shifts [4].
Why Markets Decline
Markets are driven by both economic data and human emotion [1]. Sometimes, prices rise too far, too fast, creating a bubble [5]. A correction is essentially the market adjusting to reset overextended prices [5]. While uncomfortable, this clearing out of overvalued assets is often viewed as a necessary mechanism for sustainable long-term growth [3], [5]. Less than 20% of market corrections evolve into full-blown stock market crashes [2].
What You Should Do
During a market downturn, the worst thing you can do is check your account balance every hour [5]. If you have a long-term plan, a market crash is effectively a "sale" on stocks [3]. If you have cash on the sidelines, you are buying into the market at a lower price, which can improve your long-term position when the market eventually recovers—which, historically, it always has [3], [6].
Rather than trying to time the market, investors should focus on "time in the market," allowing their investment returns to compound [3]. Selling during a decline is often the fastest way to lock in losses that might have otherwise been temporary [3].
