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What is a stock market correction, anyway?

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The stock market rallied Thursday, trying to put the year’s rocky start behind it. Wednesday had seen the biggest price decline since September; all three major stock indices were down about 10 percent from their recent highs in November and December and there was talk of a market correction. Whichever way the market is headed in the longer term, it’s useful to have some perspective. Until recently, corrections were pretty common.

“People have decided that a correction is when the stock market, by some index, loses 10 percent from its peak,” said Columbia University finance professor Charles Jones.

Why 10 percent?

“It’s completely arbitrary,” he said. “People like round numbers, and 10 percent decline seems like a pretty substantial and round number.”

It’s also completely normal — or used to be, said market strategist Quincy Krosby with Prudential Financial. When the stock market gets overheated, a correction cools things down.

And yet, “it scares the daylights out of everyone,” she said.

That’s partly because there weren’t a lot of corrections while the Federal Reserve was propping up the market by keeping interest rates near zero, Krosby said.

Market pullbacks typically happen about every year or so, she said,  but before the most recent one last summer, it had been almost four years.

“You would have thought that the pullback in August was 1929 all over again,” Krosby said. “Everyone had forgotten that is part of the market.”

Corrections also don’t tell us a whole lot about the actual economy, said William Delwiche, an investment strategist with Robert W. Baird.

There may be a lot of uncertainty in the market about oil prices and the slowdown in China, he said, but the U.S. economy is doing “fine.”

“From a macro perspective, not much has changed over the past few weeks,” Delwiche said.  “This is one of those time periods where there’s a disconnect between the stock market and the overall economy.”

However healthy a stock market correction may be, though, research has shown that investors hate losing money even more than they like making it. Those of us watching these market swings, Delwiche said, may be better off just looking away.

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