What’s the Difference Between a Stock Market Correction and Bear Market?

A stock market correction usually occurs 1 to 2 times per year on average. These corrections can vary in size and deepness but they typically require at least a 5% draw down in order to be considered a “correction”. A bear market on the other hand implies a 20% drawback from the highs and is considered a much deeper version of a “correction”.

Stock Market Corrections

Stock market corrections are a natural part of the price discovery in markets. Markets go up and down and they fluctuate based on expectations. Expectations are what guide market breadth since typically speaking markets are forward looking. Investors are looking to invest in companies that will be more profitable tomorrow, they aren’t concerned with the past as much as the future. Although past performance can be indicative of where future prices might lead, good investors are looking for “what’s next” and looking for Alpha in companies that are likely to beat expectations.

Bear Market

Bear markets are a lot less likely to occur than a stock market correction, however they still occur every so often. A bear market doesn’t necessarily have to occur during a recession the two are not mutually exclusive since the economy could be performing relatively well but the stock market could be in a bear market. The opposite could be true as well. All in all, bear markets typically occur after changes in market breadth and periods of extended price discovery due to changes in consumer sentiment. Bear markets occur every so often and they are a natural part of the boom and bust cycle of economics.

Low Expectations vs. High Expectations

Markets typically tend to turn the corner during periods of low expectations. When expectations are lofty and companies begin to miss their target this typically tends to be denoted as a period where corrections can begin to occur, especially if this is broad-based missing of expectations. However, when investors are down in the dumps about markets that is typically when you can expect a rebound to occur. It’s often better to have low expectations on a given stock or company simply because those expectations should be easier to surpass than a when investors have high expectations from a given entity. In other words, when the bar is so low that it becomes easy to surpass that is when price typically rebounds and price appreciation can begin to occur.