Traders like to butt heads over best practices when it comes to navigating the market. One of many such differences in opinion is the debate between trading reversals or trading the trend. Although we don’t expect to settle the question here and now, it might be worthwhile to take a closer look at stock market corrections. In particular, examining the time it takes for the market to recover after a pullback might give us the context we need to make that choice for ourselves.
Let’s start where all trading theories do: looking at the data. This article by Guggenheim Investments should give us some figures on the average time it took the S&P 500 to recover from various stock market corrections.
|Decline Percentage||Number of Declines||Average Decline Percentage||Average Months of Decline||Average Months of Recovery|
The figures above represent a total of 120 stock market corrections between 1946 and 2017. Recovery times for declines depend on the size of the pullback. Essentially, it averages out to one market pullback every seven months or so. However, you can’t make the mistake of assuming that these declines are distributed evenly across time. Under 40%, the recovery takes around as much time as the decline. However, over 40%, it can take twice or thrice as long. The entire 71 year period adds up to a total of 852 months. Some basic math will tell us that the market was steadily declining over 348 of those months. The simple and obvious conclusion we can draw here is that history has a bull market bias.
Stock Market Corrections Between 2020 and 2021
Before the pandemic, the S&P 500’s peak was at 3,386.20 points in February 2020. From there it plummeted by 51% to 2,237.40 points in just one month. Although the decline was sharp, the index returned to its previous high by August 2020, reaching a new high at 3,580 in September 2020. In short, it took the one-month drop roughly six months to fully recover.
Following the September high, the index made two significant 10% corrections that lasted approximately 15-20 days and took the same time to recover. Finally, from September 2020 to August 2021, there were six stock market corrections, all between 5-10%. The duration and recovery of all of them are consistent with the previous data. The pullback during the initial COVID lockdowns was evidently an outlier. For the would-be contrarians who aren’t convinced that being a bullish trader is the way to go, the real challenge is differentiating such irregular market events from the natural push-and-pull cycle between buyers and sellers.
For the rest of us, these minor dips can potentially be the best opportunity to buy, but only if you’re prepared. Analyze the drop rather than acting on first instincts. Build up your experience through repeated practice, and you’ll be able to tell whether it’s a promising chance to place a trade. We should also mention that, although this article specifically examined stock market corrections, if you cultivate the skill of recognizing dips, you’ll be able to apply it in other derivatives markets too.
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