Introduction
The market doesn’t fall or rise in linear fashion, but in cycles which are symmetrical in every time frame, you observe. This bi-directional cyclical movement of securities helps traders make money from trading in derivatives.
When volatility rises, the margin of movement in both directions increases, which expands the scope of profits and also their stop losses. The targets can be big, but so are the losses. In a situation where the volatility is below extreme levels, but above the mean, it becomes a sweet spot for scalpers to make money in a short span of minutes.
Price & Time Correction
In such cycles which involve a fall and rise in the price of the stocks, the fall is known as a market correction. Technically, a more than 10% but less than 20% fall in the price of an investment is called a correction. We use this word often, even when we see a 1% drop in the price of a security, but technically 10% is the minimum benchmark to term a drop in the price of an asset as a market correction.
Price corrections are a normal and inevitable phenomenon in the markets, usual situations of occurrence can be when the market reaches a high and cools down, or profit booking. The price correction is a money-making opportunity for derivatives traders, but a painful experience for investors.
Corrections, as we have discussed, are based on the price of an asset, there can be another type of correction in the markets known as time correction.
Time correction is a period in which the price of a traded asset stays stagnant for a prolonged period. There is no definite rise or fall in the value of the security, and the security trades in a small range.
How do people lose money?
Time correction implies no change in the value of an asset. Then how do investors lose money? The money lost by the investors is the time value of money invested in the security, the opportunity cost.
For example, if the price of your investment stays at 1,00,000 for 1 year. Then your opportunity cost is the interest rate that you could have gained if you invested that money in a Fixed deposit or other debt instruments. If the rate of deposit is 5%, then your cost of forgone opportunity is 5,000(5% of 1,00,000) which will be your loss as a value investor.
For an individual who is trading on leverage, time correction is a deadly enemy. Let’s say you have borrowed money to buy an asset at a 10% rate of interest. If the price of the investment stays the same for the next few years, then you will keep losing the interest you pay out of capital and also the opportunity cost.
Similarly, the option buyers face decay in the price of the premium during time correction, thus losing money on both bullish and bearish trade setups.
The cause of time correction can be an equal fight between bulls and bears, which creates a stalemate-like situation in the market.
Thus, time correction is more deadly for a leveraged trader, therefore it is an important variable to look upon, for a trader before taking any trades.