Investors frequently wonder where their money has gone when stock prices collapse. Actually, it hasn’t disappeared; rather, people now view their investment as having a different worth. Changes in stock prices are less about actual money movements and more about shifting perceptions of worth.
Assume you purchase 100 Apple Inc. (AAPL) shares for $150 apiece. Later, a new Apple product performs poorly, or there are problems with the supply chain. Investors begin to doubt Apple’s ability to perform well in the future as a result, and the company’s stock price decreases to $100 per share.
Although it appears as though you have “lost” $50 for each share, that money remained in the same place. The price adjustment only reflects the current price that investors are ready to pay for Apple stock. Similar to how the value of a new car decreases with time, just the market worth of the vehicle has changed and not the vehicle itself.
It is only when you sell your shares at a cheaper price that this “paper loss” materializes. To avoid getting sunk in the frequently choppy waters of the stock market, it is imperative to comprehend this idea.
Important lessons learned
- Value shifts are reflected in stock price declines rather than actual money evaporating.
- Because market value losses are represented by a decline in total market capitalization rather than being transferred elsewhere, it may appear that way.
- While falling prices can benefit short sellers, their gains are not directly attributable to the losses of long investors.
- The dynamics of supply and demand, which are influenced by investor mood and business performance, determine how much stocks cost.
- When there is market volatility, having a better understanding of these ideas can help investors make better decisions.
Knowing the Reasons Behind Stock Price Changes
Supply and demand are the primary drivers of stock pricing. A stock’s price increases when there is a high level of demand, or when more people want to purchase it than sell it. This is because buyers are willing to pay more. However, when supply outpaces demand—that is, when more people are selling than buying—the price of stocks tends to decline because sellers must reduce their asking prices in order to draw in customers.
Prices and market movements are determined by the ongoing interplay between supply, or the willingness to sell, and demand, or the readiness to buy.
When a Stock’s Demand Rises
Using one of the most prominent stock climbs in recent memory, let’s examine what occurs when a stock’s price increases. Despite the epidemic, Tesla’s (TSLA) stock price increased by more than 700% between 2020 and 2021. Investors had high hopes for Tesla because of its CEO Elon Musk’s lofty goals, plans to expand manufacturing, and ability to dominate the electric vehicle market.
As of January 2021, Tesla ranked among the most valuable automakers globally, with a market value of nearly $800 billion. This happened despite the fact that Tesla manufactured significantly fewer cars in 2020—roughly 500,000—than established automakers like Toyota and Volkswagen.
When a Stock’s Demand Declines
Now let’s look at an illustration of a stock price decline. Netflix (NFLX) revealed unsatisfactory subscriber growth for the fourth quarter of 2021 in January 2022, with only 8.3 million new members added as opposed to the 8.5 million predicted. Although this may not seem like a significant deficit, the revelation and worries about growing competition saw Netflix’s shares down 21% in a single day.
A sluggish rate of growth and the possibility of losing market share to rivals like Disney+, Hulu, and HBO Max alarmed investors. In the months that followed, Netflix’s stock price dropped further as the firm revealed a decline in subscribers during the first half of 2022. Netflix’s stock has fallen over 70% from its peak by July 2022.
When the price of a stock I own drops, what should I do?
Remain calm and think about the time frame for your investment as well as why you bought the stock in the first place—these are two of the most important things to do. Short-term volatility can occur in stocks following announcements and other occurrences.
Based on these developments, you absolutely have the option of revisiting or potentially altering your investment. If there is a sell-off, you might get a chance to buy something and add to your long position at a low price rather than selling with the crowd. The most important thing is to practice discipline in trading and focus on long-term volatility rather than short-term volatility.
How do short sellers make money when stock prices fall?
Short sellers make money by borrowing shares, selling them at a higher price at the moment, and then buying them back at a lower price later. Their profit is the difference in price between the higher selling price and the lower repurchase price.
What psychological factors have an effect on the movement of the stock market?
Fear, greed, herding behavior, and overreaction to news are all psychological factors. Investors can be influenced irrationally by these feelings to buy or sell, causing market prices to fluctuate beyond what the fundamentals would suggest.
The Takeaway:
When stock prices fall, rather than a real loss of capital, investors’ shifting perceptions and market dynamics are primarily to blame for the perceived disappearance of funds. A shift in supply and demand, frequently triggered by negative sentiment or disappointing news and resulting in more sellers than buyers, is indicated by a decline in stock prices.
This gives the impression that there is no more money. On the other hand, it merely reflects a smaller market capitalization as a result of less investor demand. The collective reevaluation of the company’s worth is represented by the “lost” value, which is not transferred to any individual.
For navigating the stock market’s frequently turbulent waters, having an understanding of this concept is essential. Remember that shares sold at a lower price are the only way unrealized losses become real.
