Curious why stock losses don't translate to someone else's gain? Dive into how market downturns unveil deeper insights into a company's value.
When the market falls, you could be forgiven for thinking that someone else is making money out of your loss, but this is not the case.
Owning a stock means owning a portion (usually very small) of a publicly-traded company. Therefore, if the value of the entire company fluctuates, so will the value of the stock.
When a share's price decreases in value, that change in value is not redistributed among any parties – the value of the company simply shrinks. The stock market is governed by the forces of supply and demand.
It is not a zero-sum game, like gambling in a casino, in which there is an equal loser for every winner, and vice versa. When an investor sells a stock, the value may fall, but they aren’t making money as they aren’t shorting it, they simply don’t own it any more.
What is actually happening to your money, is it is shrinking as the value of the company shrinks.
How a company's value can shrink
First, we need to understand how a company's value is "created." When a stock's price increases, it does so because there are more people willing to buy the stock (demand it) than people willing to sell it (supply it). This high demand in relation to supply creates value for the stock because buyers must compete against one another for it, and the more they want the stock for themselves, the more they are willing to pay for it.
The opposite occurs when a stock price decreases, which simply results from low demand in relation to supply. Just as a high number of buyers creates value, a high number of sellers erodes value.
For example, Company PLC has 42.03 million shares outstanding as of May 2020. If its share price dropped by £1, it would be roughly equivalent to a £42 million loss in (implicit) value.
So even though it might feel like someone is taking your money when your stock declines, the cash is simply disappearing into thin air with the popularity of the stock. However, this decline in popularity corresponds to something tangible — the company's ability to carry on its operations efficiently, which is reflected in its earnings.
Remember, you are part-owner of the company, so if the stock declines, it means you are part-owner of a company that is no longer perceived to be doing a great job of producing something. And, if you want to get rid of this company, you must be willing to sell it for less. Why? Because its inherent value is perceived to be worth less.
Therefore, on a very basic level, a realised loss from a stock is a reflection of the difference between the market's perception of the company when you bought it and the market's perception of it when you sold it.....
Thinking the markets are slightly inflated and might go down?
As a long term investor, moving into cash or government bonds at these lofty levels for equities is always a prudent idea particularly when rates are as high as they are.
Wait for a market retracement, and then buy back in.
It's a great way to compound growth moving forward.
As well as adopting a 'long or flat' approach, there is also a more aggressive 'short sell' approach which makes money as the markets fall.
The approach isn't for everyone, but one that is employed well when markets look very over bought.
Right now, many of the active strategies on TPP are holding a SHORT SELL US TECH position.
We've been projecting this will reap rewards before the end of Q1.
Will we be right?
Could tonights Nvidia earnings move the markets in our direction, or will it be another jump to the upside?
I guess we'll find out soon.
