Ten Smart Things Said About Market Corrections

Corrections of at least 8% in the major indexes happen at least once a year almost every year. Here are some of the wisest sayings about market corrections that I recall. You could add your own in the comment section below.

1. Market corrections make people a lot of money. They just don’t know it at the time.

2. Corrections come a lot slower than anyone expects, but once they happen they escalate faster than most could imagine.

3. Corrections are healthy only when they happen to other people’s stocks.

4. All corrections feel the same. In the beginning, people don’t believe them, then as prices continue lower and weakness spreads to more sectors, fear escalates and it leads to forced liquidation. Forced liquidation means selling, because you have to, not because you want to. Smart investors dream to be on the other side of forced liquidation.

5. At the lowest point of a correction, the fear of losing is substantially higher than the fear of missing out.

6. During corrections, correlations often go to 1.00, which means that stocks move together up and down disregarding of individual merits. If a stock manages to hold its ground and consolidates through time or even make an attempt to make new high, it is likely being accumulated by institutions. Because of the nature of their size, many institutions prefer to buy on pullbacks and during market corrections. Selloffs provide liquidity that masks their accumulation. Once the pressure from the general market is removed, those stocks tend to outperform.

7. “You don’t need analysts in a bull market, and you don’t want them in a bear market.” – G. Loeb

8. “The market is better at predicting the news than the news is at predicting the market.” – G. Loeb

9. Bottoms are made by heavy buying, not heavy selling. Stocks not going down on what appears to be bad news is a positive sign.

10. “It is not entirely clear what causes deep market corrections, but without them many of the best performing long-term investors would have never achieved their spectacular returns.” – Peter Lynch



About Predictions and Markets

Two things happen when enough people react to a prediction:

1) the prediction comes true faster than it otherwise would under normal circumstances.

2) the prediction doesn’t happen at all.

Let’s take a look at two cases that cover each of the aforementioned scenarios:

Scenario 1: If enough people believe in the bright future of a company, they start bidding up its share price even if it is still losing money every quarter. The higher stock price will allow that company to hire the brightest employees and management; to buy promising smaller competitors, which will lead to a better market position. The overall improvement in profitability will be accepted as a positive feedback by the market and even more people will buy this company shares. Everything will happen a lot faster than it otherwise would. In this case, the initial expectations of a brighter future could turn into a self-fulfilling prophecy. When good market faith meets smart management, a story stock could appreciate very quickly.

Scenario 2: If enough market participants believe that there’s a major correction coming around the corner, many would simply buy put options to protect long-term positions and ride out the storm with a minimum drawdown. One could argue that if enough people believe there’s a deep correction coming, everyone will sell and actually cause this correction to happen faster and be even bigger. The truth is that funds that actually move markets don’t go to 100% cash. They just reallocate capital between less liquid, but more lucrative asset classes and hedge. Since everyone will start buying protection, volatility will spike. Equity prices might not drop more than a few percent because most funds would be already protected and they won’t sell their positions. Put options will expire worthless. Correction predictors will be made fun of. Everything will go back to normal. By definition, deep market correction always comes by surprise for most. If enough people expect a correction and act on their perceptions, it will either not happen at all or it will be much shallower than most expect. I’d be a lot more concerned when the market is down 5% and everyone is blindly buying the dip than when the market is down 5% and implied volatility is through the roof because everyone is afraid and buying protection.

The Twitter Dilemma

Many people are emotionally invested in Twitter and don’t comprehend the reason behind its poor track record as a publicly traded stock.



Twitter is still a great product. Many of us still love it and use it every day. The problem with Twitter is that they stopped growing fast enough and when you stop growing, the market starts to pay attention to valuation. Its valuation is still steep.

When a young tech company is still growing quickly, the stock market doesn’t pay attention to valuation because it assumes that profits will come later. It is the Amazon’s model. Reinvest everything you make in projects that will fuel future growth and presumably a lot bigger profits down the road. Essentially, investors are often taking a leap of faith in:

1) their own ability to manage risk properly and

2) the ability of management to deliver.

Financial markets are forward-looking by default. They often discount events that haven’t happened yet. As a result, they will sometimes price in events that will never happen. Take the story of Yelp for example. YELP quadrupled long before it reported its first profitable quarter. Take a look what happened after this long-awaited event. The market gradualy realized that its expectations for Yelp are way too high and that its management won’t be able to deliver.


Yelp is hardly the only example of a public company rising quickly in market cap while still losing money every quarter.   Companies could be losing money because they invest heavily for future growth or they could be losing money because of a flawed business model. You want to stick with the former. The problem is that in many cases, the reason is clear only in hindsight, which means that we have only one option when dealing with momentum stocks – trust price. If price action gets us in, price action should gets us out.

It is normal for a story stock to double and triple in a year as investors’ expectations grow much faster than the ability of a company to deliver. In fact, this is the story of most momentum stocks and the reason why many of them give back 50% to 80% of their upside move.

The lesson? Always have an exit strategy, because sooner or later every trend ends.