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When Stock Prices Drop, Where Is the Money?

Have you ever wondered what happens to your socks when they disappear in the dryer? It’s a mysterious…
When Stock Prices Drop, Where Is The Money?

Have you ever wondered what happens to your socks when they disappear in the dryer? It’s a mysterious phenomenon that might never be explained.

Many people are puzzled when they discover their brokerage account balance has suddenly dropped. Where did that money disappear to?

Thankfully, money made or lost from a stock doesn’t vanish into thin air. Keep reading to learn what happens to it.

KEY TAKEAWAYS

  • When a stock drops and an investor loses money, that money isn’t handed over to someone else.
  • Declines in account value show investors are losing interest, and their views on the stock are changing.
  • Stock prices depend on the number of people who want to buy and sell them, which is influenced by how investors see their worth and potential.
  • If you keep your shares without selling them, you can recover any lost value.

Disappearing Money

Before we discuss how money vanishes, it’s essential to know whether the market is going up (bull market) or down (bear market). The price of stocks is driven by how many people want to buy and sell them. Changes in stock prices (and when you buy and sell shares) decide whether you make or lose money.

Buy and Sell Trades

If you buy a stock for $10 and sell it for just $5, you lose $5 per share. You might think money goes to someone else, but that’s inaccurate. It doesn’t go to the person who buys the stock from you.

For instance, imagine you planned to buy a stock at $15, but the price drops to $10 per share before you do. You buy at $10 but don’t gain the $5 decrease in the stock price. Instead, you get the stock at the current market value of $10 per share.

You might feel like you saved $5 but didn’t make a $5 profit. However, if the stock goes up from $10 to $15, you’ll have a $5 (unrealized) gain.

Similarly, if you own a stock and its price falls, causing you to sell it at a loss, the person buying it at that lower price doesn’t automatically gain from your loss. They have to wait for the stock to rise above that level to make a profit, whether unrealized or realized.

When your stock price drops, no one, not even the company that issued the stock, gets the money from that decline. Changes in stock prices don’t result in money being handed to certain investors. The price changes happen because of supply and demand and the transactions made by investors.

Short Selling

Some investors work with a broker to sell a stock at a high price, expecting it to drop. This is known as short-selling.

When the stock price drops, the short seller makes money by purchasing the stock at a lower price and ending the trade. The profit is the difference between the selling and buying prices, which the broker pays.

Short-sellers make money when a stock price falls, but they do not specifically take money from you if you lose when selling a stock. They are doing their transactions and can also lose or make mistakes, just like investors who own the stock.

The question remains: Where did the money disappear?

Implicit and Explicit Value

The simplest explanation is that the money vanished because fewer people wanted the stock, causing its price to drop as investors sold their shares due to less positive opinions.

How money can disappear into thin air shows how complex and sometimes puzzling it is. Money is abstract, stirring our dreams and desires, and practical, the tool we use to buy what we need daily.

This double nature of money represents the two aspects of a stock’s value: the hidden and obvious worth.

Implicit Value

For instance, a pharmaceutical company owning a patent for a cancer cure may be seen as much more valuable than a local convenience store.

For instance, a pharmaceutical company owning a patent for a cancer cure may be seen as much more valuable than a local convenience store.

Implicit value is determined by how investors view and anticipate the stock’s future revenues and earnings.

When the implicit value changes and is influenced by intangible factors like beliefs and feelings, the stock price changes, too. For example, if the implicit value goes down, stock owners lose value because their assets are worth less than what they paid. No one else gets the money; it just disappears because of how investors see things.

Explicit Value

Now that we’ve discussed the unusual aspects of money mentioned above, we must also consider how money represents the tangible value of a company, known as explicit value.

Called the accounting value or book value, explicit value is figured out by adding up all the assets and subtracting the liabilities. This shows how much money would be left if a company sold all its assets fairly and paid off all its debts and bills.

Explicit value is crucial because it forms the basis for implicit value. Investors judge a company’s financial health and performance based on its explicit value, which influences its implicit value.

Important: If your brokerage account loses value, you can still recover and potentially make more than the loss if the stock price goes up again—don’t sell your shares.

Disappearing Trick Revealed

Imagine Cisco Systems Inc. (CSCO) had 5.81 billion shares available for trading. If the value of each share went down by $1, the overall loss in value would be more than $5.81 billion.

Since Cisco has billions of dollars in assets and earns profits, we understand that the change doesn’t happen in the company’s tangible value. So, the concept of money vanishing suddenly becomes more understandable.

In simple terms, investors, analysts, and market experts believe that their expectations for the company have become more limited. As a result, investors are not willing to pay as much for the stock as they were previously.

When investors lose interest in a stock, its demand decreases, causing the price to drop.

The Explicit Drives the Implicit

So, belief and expectations can turn into actual money, but it’s because of something tangible influencing perception. The company can produce something valuable and necessary for individuals and businesses.

The more a company satisfies demand for its products, the more money it will make and the more trust investors will have.

1. Should I Sell Stock If It Goes Down?

Ans: Unless there’s a major problem with the company’s finances (or you need the money), it might be best to wait and see if the stock price goes back up. Don’t sell in a panic.

2. Do You Lose Money When Stocks Drop?

Ans: Your stock investment’s value may decrease when the stock market decreases. But if you still hold onto your shares (and didn’t sell them), that value can return when the market improves. So, although you might lose value temporarily, it can change for the better.

3. What Are Unrealized Gains and Losses?

Ans: An unrealized gain is when the value of something you own goes up, while an unrealized loss is when it goes down. If you sell the asset, these gains or losses become real and don’t change. But if you keep owning it, the gains or losses can still change.

The Bottom Line

In a bull market, people generally believe the market will keep growing and making things happen. This confidence comes from evidence that things are being created or will be. Investors in a bull market can profit from this positive outlook.

In a bear market, the opposite occurs. In simpler terms, the stock market can create or destroy wealth on a large scale.

While the mystery of disappearing socks in the dryer remains unsolved, you can attribute it to how investors perceive the situation when you’re curious about why a stock price changed.

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