Table of Contents
- Have you ever wondered where your socks go when they mysteriously disappear in the dryer? It’s a perplexing phenomenon that may never have a clear explanation. Similarly, stock prices can seem just as mysterious, as they fluctuate based on a variety of factors that may not always be immediately clear. Understanding the forces behind stock prices requires diving into investor behavior, market sentiment, and the ever-changing economic landscape.
- Similarly, many investors find themselves puzzled when they notice their brokerage account balance has suddenly dropped. Where did that money go?
- Rest assured, money made or lost from stocks doesn’t just vanish into thin air. Keep reading to understand exactly what happens to it.
KEY TAKEAWAYS
- When a stock declines and an investor loses money, that money isn’t transferred to someone else.
- Declines in account value reflect that investors are losing interest, signaling a shift in their perspective on the stock.
- Stock prices are driven by the demand to buy and sell, which is influenced by how investors perceive their value and potential.
- If you hold onto your shares without selling, you have the potential to recover any lost value.
Disappearing Money
Before diving into how money disappears, it’s important to understand whether the market is trending up (bull market) or down (bear market). Stock prices are influenced by supply and demand—how many people want to buy and sell. The fluctuations in stock prices, combined with timing your buys and sells, determine whether you profit or incur losses.
Buy and Sell Trades
If you purchase a stock for $10 and sell it for just $5, you lose $5 per share. It might seem like the money is going to the person who buys the stock from you, but that’s not the case. The loss doesn’t directly transfer to them.
For example, if you plan to buy a stock at $15, but the price drops to $10 per share before you make the purchase, you buy at $10. You don’t gain the $5 price drop; instead, you acquire the stock at its current market value of $10 per share.
While it might feel like you saved $5, you didn’t make a $5 profit. However, if the stock price increases from $10 to $15, you’ll see an unrealized gain of $5.
Similarly, if you sell a stock at a loss because its price has fallen, the buyer purchasing it at that lower price doesn’t instantly profit from your loss. They must wait for the stock to rise above that price to realize their gain, whether unrealized or realized.
FAST FACT
When the price of your stock drops, no one, not even the company that issued the stock, directly gains from that decline. Price changes don’t lead to money being transferred between investors. These fluctuations occur due to supply and demand and the transactions made by investors.
Short Selling
Some investors collaborate with a broker to sell a stock at a high price, anticipating a price drop. This strategy is called short-selling.
When the stock price falls, the short-seller profits by purchasing the stock at a lower price and closing the trade. The profit is the difference between the selling and buying prices, which the broker pays.
Short-sellers make money when a stock’s price declines, but they don’t directly take money from you if you lose while selling a stock. They’re simply executing their transactions and, like all investors, can also make mistakes or face losses.
So, the question remains: Where did the money go?
Implicit and Explicit Value
The simplest explanation for money disappearing is that fewer people wanted the stock, causing its price to drop as investors sold their shares due to less favorable opinions.
How money can seemingly vanish into thin air highlights its complexity and sometimes puzzling nature. Money is both abstract, stirring our dreams and desires, and practical, serving as the tool we use to purchase what we need every day.
This dual nature of money mirrors the two sides of a stock’s value: the hidden and obvious worth.
Implicit Value
For example, a pharmaceutical company holding a patent for a cancer cure is likely seen as much more valuable than a local convenience store.
Implicit value is shaped by how investors perceive and forecast a stock’s future revenues and earnings.
When the implicit value shifts due to intangible factors like beliefs and emotions, the stock price follows suit. For instance, if the implicit value declines, stockholders lose value because their assets are now worth less than what they originally paid. No one else gains that money; it simply disappears, influenced by how investors perceive the situation.
Explicit Value
Now that we’ve explored the unique aspects of money, we must also look at how money reflects a company’s tangible value, known as explicit value.
Often referred to as accounting value or book value, explicit value is calculated by adding up all the assets and subtracting liabilities. This calculation shows how much money would remain if a company sold all its assets and paid off its debts and obligations.
Explicit value is vital because it forms the foundation for implicit value. Investors assess a company’s financial health and performance based on its explicit value, which in turn influences its implicit value.
- Important: If your brokerage account loses value, you can still recover and potentially earn more than the loss if the stock price rises again—just don’t sell your shares.
Disappearing Trick Revealed
Imagine Cisco Systems Inc. (CSCO) has 5.81 billion shares available for trading. If the value of each share drops by $1, the total loss in value would exceed $5.81 billion.
Given that Cisco holds billions in assets and generates profits, we know that the change doesn’t affect the company’s tangible value. This makes the idea of money seemingly vanishing easier to understand.
In simple terms, investors, analysts, and market experts now believe that their expectations for the company have become more limited. As a result, investors are no longer willing to pay as much for the stock as they once were.
FAST FACT
When investors lose interest in a stock, its demand decreases, causing the price to drop.
The Explicit Drives the Implicit
Belief and expectations can transform into actual money, but this happens because something tangible is influencing perception. The company is able to produce something valuable and essential for both individuals and businesses.
The more a company meets the demand for its products, the more money it generates and the greater the trust investors will place in it.
The Bottom Line
In a bull market, people generally believe the market will continue to grow and thrive. This optimism is fueled by evidence that things are being created or will be in the future. Investors in a bull market can profit from this positive outlook.
In a bear market, the opposite happens. Simply put, the stock market has the power to create or destroy wealth on a massive scale.
While the mystery of disappearing socks in the dryer remains unsolved, you can understand stock price changes by considering how investors perceive the situation.
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