It’s something that we hear all the time through the media but with little explanation. When the stock market starts to fall there are 3 general explanations as to why this may be happening.
Pull back – A market pullback is when the market or a particular stock decreases by 5% from its recent high. Recent generally meaning 12 months. They are generally very short lived
Correction – A market correction can be seen when price has fallen by 10% from its high. The high will depend on the investor. As mentioned above it can include the 12 month high or an all time high. A correction could simply be investors cashing in on some of their recent returns. The key is ensuring that there is nothing wrong with the company itself and it is really just a market reaction. Despite being daunting a correction will only last a few months
Bear Market – This is when price has decreased by 20% or more. This is where things get tricky because amateur investors get nervous and fear spreads throughout the market. It makes it hard to identify when price will turn around.
How to take advantage
Below is a 12 month chart of ANZ Bank. As you can see the black circle represents a 12 month high of $32.95. The red arrow on the centre right is what it is trading at today being $29.40.
If we apply our learnings from above we know that a market correction is a price drop of 10% of recent highs. So 10% of $32.95 is $3.29.
If we take away $3.29 from the price high of $32.95 we get $29.66 which is close to what the stock is currently trading at. This may be a good time to buy. But we want more assurance. So we look at the past.
If we look at the same chart we can find another time where the price appeared to drop significantly. Again looking at the black circles we can see that at that time price was at a 12 month high of $31.84 and dropped to $28.61.
$31.84 – $3.18 (10%) = $28.66. A number very close to the bottom price of $28.61. This could give an investor enough reason to believe that now is a good time to buy as this appears to be a pattern for this stock. But as with investing nothing is guaranteed and past performance does not guarantee future success.
It can also act as a warning sign that if you own a stock and it’s currently trading at its 12 month high a market correction may be on its way.
Again, this information is for educational purposes only. In no way am I giving advice or recommending this stock be purchased.
A cheeky word from our legal guy. The information in this email is for entertainment and education purposes only. There is no explicit or implied endorsement of any particular companies. The author owns zero shares in the companies mentioned. This is not intended to be taken as advice as we are not licensed financial advisers.