The Investment Scientist

How Often Do Market Corrections Happen?

Posted on: August 5, 2011

Market Correction

Market Correction

As of yesterday, the market had dropped more than 10% from its recent peak on 5/2. Many investors are very concerned. I am too.

Whenever I find my emotions are unsettled, I study historical data. That has always given me a perspective unavailable from the tick-by-tick reporting of the real-time financial media.

The following table summarizes the frequencies of market declines of various magnitudes.

Magnitude of market decline Frequency of occurrence
>5% Every year
>10% Every two years
>20% Every five years
>30% Every ten years
>40% Every twenty-five years
>50% Every fifty years

What have I learned from the history of market declines?

  1. The market decline that just happened (a 10% decline) is nothing unusual. It happens on average once a year. In fact, you should expect it to happen every year going forward.
  2. It is impossible to predict when a market decline will start, what its magnitude will be, and how long it will last. Take 2010 for example. The market went up 9.15%, turned around and dropped 16.05%, turned around and rallied 22.99%, to end the year up 12.7%.
  3. There has always been a rally somewhere after a major market decline.

No market decline is comfortable. It’s human nature wanting to put a stop to the anxiety by getting out of the market. Before you do that, however, think about the consequences. When would you feel comfortable enough to get back in again? Most probably after the market has rallied past today’s level. Jumping in and out of the market according to your own comfort level is a recipe for buy high/sell low, a sure way to lose money. You’d be better off putting your money under a mattress.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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