It’s no secret that the stock market can fluctuate without warning. If you’re new to the investment game, what happens when your stock goes negative? If a stock goes down, do you owe money to your broker? When should you consider selling your 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 financial quarter, or face a major scandal, stock prices can quickly descend. And 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 would also be true: If the stock price increased to $12 per share, the value would increase by 16.67%. The more stock you own, the more your value would decrease or increase as the price changed.
If you held the investment when the price went up, you'd have unrealized gains on an investment that had yet to be sold (also colloquially known as “paper profit”). If the stock market went down and the investment price dropped below your purchase price, you'd have a “paper loss.” After you sold the investment off, you’d either reap the earnings from the gains or get back less than what you invested.
Two of the most common conditions that can affect the value of your investments are bull markets and bear markets.
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?
During a bear market, 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?
For new investors, one of the most common concerns is related to the value of their investments. It’s not unusual to wonder, “If a stock goes down, do you 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 on whether you're buying stocks on a margin loan or with cash.
Selling Stocks on a Margin
More experienced investors may use more complex strategies, like buying stocks on margin (loan) to increase their 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 riskier strategy and isn't recommended for beginning investors.
Selling Stocks at a Loss
If you decide to sell your investments at a price below what you paid, you'll experience a realized loss. Smart investors occasionally “cut their losses” if they’re afraid that the stock price will drop even further.
Other investors may decide to hold on to their investments in the hopes that they'll increase. The idea that industries will naturally increase and decrease in value is the idea behind Dow’s Theory.
What Is Dow’s Theory?
The Dow Theory dates back to 1901 when economic journalist Charles H. Dow wrote a hypothesis about tracking financial markets. Comparing it to the high and low of an ocean tide, Dow suggested that the performance of any given industry against the entire market could 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). Investors can take advantage of low prices because the rest of the market hasn't “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 start investing as the stock price climbs. This ultimately causes prices to rise 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/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 negative? Is it time to re-evaluate your sales strategy – or should you hold on to the stock and wait for a bull market?
There isn't one universal answer: Every situation is unique and investments can gain or lose value at any time. When determining whether it’s time to buy or sell, use all of the available tools and resources to make your decisions.
Track Investment Value Online
First, it’s important to track the value of your investments online. While investing platforms provide tools, consider downloading 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 Current with Financial Information
Next, be sure to read the financial news, prospectus, and research available about 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.
Any time that markets drop in value, it’s natural to wonder about what happens when your stock goes down. Through understanding gains and losses, Dow’s Theory, and a company’s trajectory, you'll be better equipped to make wiser financial decisions to protect and increase your stock portfolio's value.
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