When the stock price drops, where is the money?

Have you ever wondered what happened to your socks when you put the socks in the dryer and never saw them again? This is an unexplainable mystery, and there may never be an answer. Many people feel the same way when they suddenly notice a sharp drop in their brokerage account balances. Where did this money go?

Fortunately, the stock gains or losses have not disappeared. Read to understand what happens to it and what causes it.

Key points

  • When stocks plummet and investors lose money, the money will not be redistributed to others.
  • In essence, it has disappeared without a trace, reflecting the weakening of investor interest and the decline in investor sentiment on the stock.
  • This is because stock prices depend on supply and demand and investors’ perceptions of value and feasibility.

Disappeared money

Before we understand how currencies disappear, it is important to understand that whether the market is rising (called a bull market) or falling (called a bear market), supply and demand will drive stock prices. The fluctuation of stock prices determines whether you make money or lose money.

Buying and selling transaction

If you buy stocks for $10 and sell them for only $5, you will lose $5 per share. It may feel that money must be given to other people, but this is not the case. It will not be attributed to the person who bought the stock from you.

For example, suppose you want to buy a stock for $15, and before you decide to buy, the stock drops to $10 per share. You decide to buy at a price of $10, but you do not get a depreciation of the stock price of $5. Instead, you acquired the stock at the current market value of $10 per share. In your opinion, you saved $5, but you didn’t actually make a profit of $5. However, if the stock rises from $10 to $15, you will get $5 in earnings, but it must rise to get you $5 per share.

This is also true if you hold stocks and the price drops, causing you to sell at a loss. The person who bought it at a lower price—the price at which you sold it—may not profit from your losses and must wait for the stock to rise to make a profit.

The company that issued the shares will not get funding from your share price decline.

Short selling

Some investors trade with brokers to sell stocks at expected high prices and expect it to fall. These are called short sales transactions. If the stock price drops, short sellers make a profit by buying the stock at a lower price-closing the transaction. The net difference between the buying and selling prices is settled by the broker. Although short sellers profit from falling prices, they do not take your money when you lose money on stock sales. On the contrary, they trade independently with the market, and like investors who own stocks, they have the same chance of losing money or making mistakes in trading.

In other words, short sellers profit from falling prices, but this is a different transaction from bullish investors who buy stocks and lose money due to falling prices.

So the problem still exists: Where did all the money go?

Implicit and explicit values

The most direct answer to this question is that as the demand for stocks declines, or more specifically, investors’ favorability for it declines, it actually disappears out of thin air.

However, the ability of this currency to dissolve into the unknown shows the complexity and somewhat contradictory nature of currency. Yes, money is a trailer-it is both intangible, flirting with our dreams and fantasies, but also concrete, it is something we get daily bread. More precisely, this dual currency represents two parts that make up the stock market value: hidden value and explicit value.

Implied value

On the one hand, value can be created or dissipated as the hidden value of stocks changes, which is determined by the personal opinions and research of investors and analysts. For example, a pharmaceutical company with patents for the treatment of cancer may have a much higher implicit value than that of a corner store.

According to investors’ perceptions and expectations of stocks, the implied value is based on revenue and profit forecasts. If the implicit value changes-which is actually produced by abstract things such as beliefs and emotions-the stock price will change accordingly. For example, the decline in implicit value causes stock owners to suffer losses because their assets are now worth less than their original prices. Likewise, no one else will definitely receive this money; it has lost the recognition of investors.

Explicit value

Now that we have covered certain “unreal” characteristics of currency, we cannot ignore how currency also represents explicit value, that is, the specific value of a company. Known as the accounting value (or sometimes the book value), the explicit value is calculated by adding up all assets and subtracting liabilities. Therefore, this means that if a company sells all of its assets at fair market value and then pays off all liabilities (such as bills and debt), there will be the remaining amount.

However, without explicit value, the hidden value of the company will not exist. The investor’s explanation of how the company uses its explicit value is the force behind the company’s hidden value.

The implicit value of stocks depends on the views of analysts and investors, while the explicit value depends on its actual value, that is, the company’s assets minus liabilities.

The vanishing trick revealed

For example, assuming that Cisco Systems Corporation (CSCO) has 5.81 billion shares outstanding, this means that if the value of the stock drops by $1, it is equivalent to a loss of more than $5.81 billion in (implied) value. Since CSCO has billions of dollars in specific assets, we know that this change does not happen with explicit value, so ironically, the idea of ​​money disappearing out of thin air becomes more practical.

Essentially, what is happening is that investors, analysts and market professionals announce that their forecasts for the company have shrunk. Therefore, investors are unwilling to pay more for stocks as they did before.

When investors’ perception of stocks weakens, the demand for stocks will also weaken, and the prices will also fall.

Therefore, beliefs and expectations can be turned into hard cash, but only because of something very real: the company’s ability to create something, whether it is a product that people can use or a service that people need. The better things a company creates, the more profitable the company will be, and the higher the trust of investors in the company.

In a bull market, people generally have a positive attitude towards the market’s ability to continue to produce and create. Because if there is no evidence that something is or will be created, this perception will not exist, so everyone in the bull market can make money. Of course, the exact opposite may happen in a bear market.

In other words, treat the stock market as a huge tool for creating and destroying wealth. No one really knows why socks never come out after entering the dryer, but next time you want to know where the stock price comes from or where it goes, at least you can attribute it to market perception.


READ ALSO:   Annual basis
Share your love