When a Stock Price Falls, What Happens to Your Money?
On any given day, the stock market can fluctuate up and down without warning. While the goal of every investment is to make money, new investors may worry about losing money if their stocks go down. Does it mean investors owe money to their brokers? Should new investors consider selling their investments?
Before you start investing, it’s important to understand what happens to your money if your stock goes down. Here’s what you need to know about your stocks, bonds, mutual funds and more in bull and bear markets.
What Happens When Stocks Go Down?
Stock prices can drop for many different reasons. When companies announce layoffs, poor financial performance during a quarter, or face a major scandal, stock prices can quickly descend.
When stock prices decrease, the total value of an investment drops accordingly.
Say that you bought one share in ABC Company at $10. The price decreased to $8 over the course of a week, meaning that the value of your stock decreased by 20%. The converse is also true: If the stock price increased to $12 per share, the value would also increase by 16.67%. The more stock you own, the more your value would increase or decrease as the price changes.
If you hold the investment when the price goes up, you have unrealized gains on an investment that has yet to be sold (also colloquially known as “paper profit”). If the stock market is down and the investment price drops below your purchase price, you have a “paper loss.” After you sold the investment off, you’d either reap the earnings from the gains or get less than you invested back from the loss.
Two of the most common conditions that can affect the value of your investments are known as a bull market and a bear market.
What Is a Bull Market?
A bull market occurs when a financial market is expected to rise. This increase can be driven by a number of conditions, including increased sales, rising consumer confidence, or optimism towards a productive economy.
When a market increases by 20% after a sustained price drop, a market is considered to be on a “bull run.” During this time, investors often enjoy increased earnings and tend to hold stocks until they reach a target price.
What Is a Bear Market?
The opposite of a bull market is a bear market, where market prices experience a long drop in prices.
Unlike a “bull run,” analysts can declare a bear market when the level drops by 20% or more. Bear runs can be caused by negative market indicators, such as contracting economic conditions, job losses and investor sell-offs.
If My Stocks Go Down, Do I Owe Money?
One of the most common concerns new investors have is related to the value of their investments. It’s not unusual to wonder: “If my stocks go down, do I owe money?”
If your stocks, bonds, mutual funds, electronically-traded funds, or other securities lose value, you won’t normally owe money to your brokerage. You may not, however, receive all of your money back if and when you sell. It depends if you are buying stocks with cash, or on a margin loan.
Selling Stocks at a Loss
If you decide to sell your investments at a price below what you paid, you will experience a realized loss. Smart investors will sometimes take a strategic loss if they are afraid that the stock price will drop even further. This is where the phrase “cut your losses” comes from.
Other investors may decide to hold on to their investments in the hopes that they will increase. The idea that industries will naturally increase and decrease in value is the idea behind Dow’s Theory.
Selling Stocks on a Margin
There are more complex strategies in which you may buy stocks on margin (loan) to increase your purchasing power. In this case, if the value of stocks in your account goes below the maintenance margin, your broker will require you to sell some of the stock – or add more cash to cover the shortage. This is a more risky strategy and is not recommended for beginning investors.
What Is Dow’s Theory?
The Dow Theory dates back to 1901, when economic journalist Charles H. Dow wrote a now-famous hypothesis about tracking financial markets. Comparing it to the high and low of an ocean tide, Dow suggests that the performance of any given industry against the entire market can be used to predict long-term trends (instead of measuring pricing spikes and drops).
There are three main parts to Dow’s Theory: The accumulation phase, the public participation phase, and the panic phase (also known as the distribution phase).
During the accumulation phase of Dow’s Theory, well-informed investors start purchasing stock of companies in an industry, despite negative opinion. During this accumulation phase, investors can take advantage of low prices because the rest of the market has not “caught on” to the potential value.
Public Participation Phase
As the stock value continues to rise, Dow’s Theory goes into the public participation phase. During this period, other investors will start investing as the stock price climbs. This ultimately causes prices to raise in value, providing unrealized gains for early investors.
Once a stock hits new highs and analysts start scrutinizing it, Dow’s Theory hits the third and final phase: the panic phase (also known as the distribution phase). At this point, early investors begin to sell off their stocks at the potentially highest point. These sellers reap realized gains from selling back stock to the market while late investors may face potential unrealized losses.
Will My Stock Prices Go Back Up?
So what happens when your stocks go down? Is it time to re-evaluate your sales strategy, or should you hold on to the stock and wait for a bull market?
There is no one universal answer to this question. Every situation is unique and investments can gain or lose value at any time. When determining when it’s time to buy or sell, use available tools and research to make your decisions.
Track Investment Value Online
First, it’s important to track the value of your investments online. While your investing platform will provide some tools, you can also download apps that will help you track prices and changes in real time. The PageOnce and Bloomberg apps are among the best personal finance apps to help you track investments.
Stay Up to Date with Financial Information
Next, be sure to read the financial news, prospectus, and research available on your investment. By understanding the eight key facts of investing – including a company’s business model, competitive advantage, and profit margin – you can make educated decisions about your investment plan.
Anytime markets drop in value, it’s natural to wonder about what happens when your stocks go down. Through understanding gains and losses, Dow’s Theory, and a company’s trajectory, you can make the best decisions possible to protect and increase the value of your stock portfolio.
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