When a stock price goes down, is it that many people have sold and now have that value in cash OR is it that the market just decides the stock price is now worth less collectively?
In: 103
It’s a change in the balance. A stock price is set at a balance of it being sold and bought. Say a stock is at 75 dollars. At this specific moment 1000 people are buying and selling it at that price. Now the next day there is a moment where 1000 people are selling buying 1500 are buying. Not due to this imbalance the price goes up to $90. It goes up and stops when some sellers saw the price rise, now 1200 are selling. As well as buyers decided to walk way and only 1200 remain. On day three people want to cash out on this new price. 3000 are selling but only 1000 are buying. The price falls again until their is an equilibrium.
Now this is very over simplified but that is the point of eli5.
Lets go even eli5-er.
You own a share of Widgets R Us (WRU). You bought it for $100. The current value is 100. A guy offers to buy it for 150. The value is now 150. Note you don’t sell it, you don’t make any money. It’s a theoretical value, only realized if you sell. A few weeks later it comes out WRU is coming out with a product, pineapple pizza. Everybody knows this is a bad idea and you wan’t to get out. You call that guy who offered you 150 and he says he isn’t interested anymore. You offer it for sale at 150, 140, 130…100. You cant even break even. Some lady offers you $70 for it. You consider it. The current value is now $70. Note that no money went anywhere. You decide to hold. You think it will eventually go up. A couple weeks later you get scared and ask the lady if she still wants to buy it. Shes says yes but now only offers you $40. It’s current value is 40. You again decide to hold. You decide to weather this storm. These things always happen in the stock market and it can recover, even if it takes years. A few days later you find that the report of the new product was just some weird employee ordered pineapple pizza for lunch and the media just got the facts wrong and blew it all out of proportion. The company is actually doing better than they projected people start to call you. First the lady who now is offering $100, then the first guy offering 150, no 160. A third guy calls offering $200. The value is now 200.
You could sell here and make 200. Notice that no money goes anywhere until a sale happens. Here you decide not to sell. You know this stock is a long term investment. You see it’s value going much higher in the future. You are thankful you didn’t sell during that panic phase and took it as a life lesson. As long as you are well diversified you are in a good position. Dips will happen. The trick is not to get scared and bail out, locking in your losses. The marked will recover.
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