Over time, equity markets tend to move higher. It's the nature of investment, that the more cash that needs a home, the higher asset prices go. But interruptions in this process are not uncommon: although mostly unwelcome, many are healthy and necessary functions of financial markets.
We're talking about corrections and other reversals such as bear markets, that interrupt the smooth upward price progression of assets, securities and other market price indicators.
For now, we'll steer clear of the concept of a market crash - as this phenomenon is not the same and is most often the result of highly dysfunctional markets.
Simply by measuring the inflows into funds over time, we know that the market for investment has grown rapidly as the world's population rises.
Funds to provide for that growing population's retirement provision are no longer enough and we're advised to make our own private contributions, where possible, for investing in our future.
Never before have there been so many different products available for private and institutional investors alike. Exchange-traded funds and derivative securities allow us access to markets that were once only traded by professionals.
But there are still only a limited number of investment opportunities for the rapidly-growing demand from those with ever-larger amounts of cash to invest.
This is why certain, popular assets and securities can begin to become overvalued, and here's where it's most likely a correction will occur.
Corrections and bear markets
Just as a forest fire releases a short, destructive force that kills off the aged and diseased plant life to make room for new growth to flourish, so too a correction relieves markets of overvaluations and nascent bubbles and brings prices back to levels where investment can thrive.
A correction is technically described in investment parlance as a fall in the price of an asset or security, or other price indicator, of more than 10% from its most recent cyclical peak.
Corrections are healthy for markets, and so long as investors don't panic sell their assets during the event it's likely they'll soon make back the losses once the correction is over.
Bear markets last longer and go deeper. Technically speaking, a bear market interruption in a bull market is fall of more than 20% from the most recent cyclical peak over the course of least two months.
But again, panic selling by inexperienced investors exacerbates a bear market.
What triggers a correction?
High valuations. From many years of experience, professional investors know when valuations are getting lofty. Brokerages and institutional investors will use certain metrics by which they measure valuations.
The most common is the price/earnings (p/e) ratio. Different sectors and, indeed, companies will have different p/e ratios that are regarded as normal, but simply put, this is the ratio between a company's selling price and its earnings per share (EPS).
If a company's EPS is £2 and its shares are currently selling for £20, it has a p/e ratio of 10.
So, why were we talking about lofty valuations in the tech sector six months ago - yet no correction?
This could have been for any number of reasons: that earnings continued to impress; large amounts of leveraged, speculative cash supporting prices; mergers and acquisitions.
Corrections often also need a catalyst. This can be an economic shock, geopolitical turbulence or other unexpected event, that causes some reallocation of investment funds.
Anatomy of a correction
Whatever the catalyst, experienced investors will use it to sell down what they think are their most overvalued holdings. Here's where equity prices appear to drop dramatically.
But now these investors have unallocated funds from this sell down. If, as they suspect, there's going to be a correction that lasts a few weeks, they'll find somewhere nice and safe to put it for the duration - short-term bonds.
Most likely one- or two-month Treasury bills, which are highly liquid and soon mature, meaning they can be quickly converted back to cash and reallocated to the stocks that were sold ahead of the correction.
This would be the ideal way to deal with a stock market correction. You've simply taken a minor hit to reallocate funds for a short period, before reinvesting.
Of course, it hardly ever runs this smoothly, but even if you did nothing it's not the end of the world.
If you don't have the skills, timing or market access to reallocate your portfolio during a correction, the next best thing you can do is nothing.
Riding out a correction
Veteran investors will know exactly how common corrections are and that their impact is fleeting.
At the more speculative end of the investment spectrum, however, investors need to be more careful. Especially when investing from highly leveraged positions, as losses during a correction can become heavy very quickly and leverage could multiply those already-heavy losses.
The "do-nothing" approach can help in either circumstance. If you own stock in a company whose shares are falling fast, don't panic. Hold those shares if it's a good company as the odds are it will make back its losses in a matter of weeks following the correction.
If you're using leveraged finance to speculate on price movements make good use of your stop losses in case your position misfires. Other than that - don't play at all while markets are volatile. You'll get burned one day.
Corrections are common and widespread
It's been iterated above. Corrections are common. And when they happen, they usually happen everywhere. The chart below shows a number of corrections on the S&P 500 - all since 1990.
Charted against the S&P 500 corrections are the corresponding price movements on the MSCI Emerging Market index, and it shows that nearly all S&P 500 corrections turned into a correction in emerging markets too.
Such an event can appear dramatic, such as in February 2018 when the Dow Jones Industrial Average corrected (the Dow 30), losing a record 1,175 points in one day. Japan's Nikkei reacted with a 1,072 point single-day drop of its own.
Corrections are infectious but not deadly. All the corrections seen on the S&P 500 since the financial crisis have recovered the pre-correction price levels within five months - most of them within a fraction of this time.
Bear markets: less common, more severe
Bear markets are more severe. The most recent bear market was the financial crisis: beginning in September 2007, it took until February 2009 for the index to re-enter a bull market (a rise of 20% from its lowest point) and a further four years to recover its pre-crisis levels.
From peak to trough, the S&P 500 lost around 57% during the financial crisis bear market.
The causes of bear markets differ too.
They may be catalysed by technical reasons just like corrections, where overbought assets are the main trigger. But they go much deeper.
Bear markets are more the result of fundamental economic weakness or dramatic market shocks.
The financial crisis of 2007-09 triggered a recession as the cost of bank bail outs fostered austerity measures that crippled global demand.
The bear market of 2000-02, however, occurred as the dot-com bubble burst, causing many investors to question fundamental market valuations after years of what Alan Greenspan called "irrational exuberance".
The selling, therefore, spread across sectors, and was exacerbated and prolonged by massive geopolitical turmoil following the September 11 attacks and the subsequent build up to the war in Iran.
Spotting a correction
Many corrections are easy to spot but impossible to time. The correction that started in February 2017 was a long time coming.
Let's go back to the price/earnings metric. This can be used to predict corrections as stocks approach overpriced territory.
Before the February 2017 correction began, the S&P 500 index p/e average stood at 20. Just over a week later it was 18. The average p/e ratio on the S&P 500 since 1954 is 16.
In the months leading up to the dot-com bubble bursting, the S&P 500 p/e ratio rose close to 30.
Dividend yields can also be used in a similar way: the higher share prices rise in relation to the dividend paid, the lower the yield and more expensive the market.
Watch also for signs of extra bond market activity. Those investors who have spotted a correction coming, might start to allocate some of their portfolio away from equities. They'll look for bond and, perhaps gold havens to park their funds while the correction passes.
The most important point to make here is that corrections, bear markets, and crashes all involve sharp price or value losses - but that is the only similarity they share.
A bear market is the result of strains on economic sentiment - caused either by fundamental weakness or dramatic shocks.
A correction is usually just a short-term price readjustment. A market reset button, perhaps, that allows for overpricing to be washed from the system and business to resume fast and confidently.
Finally, let's talk about crashes. These are massively dysfunctional aspects of market behaviour, emblematic of either mass panic, or gross ineptitude.
Flash crashes have happened when unintentionally large trades have been entered and triggered large-scale sell-offs by high-frequency traders.
Corrections are neither bear markets nor crashes so, don't worry about them. Ride them out and emerge the other side wiser for your experience. For if you are to become a veteran investor, you'll be encountering many more.