Over the last 100years, there have been several large stock market crashes that have plagued the American financial system. For example, during the Great Depression of 1929, stock prices dropped to 10% of their previous highs and during the crash of 1987, the market fell more than 20% in one day.
Key Takeaways
- Stock markets tend to go up. This is due to economic growth and continued profits by corporations.
- Sometimes, however, the economy turns or an asset bubble pops—in which case, markets crash.
- Investors who experience a crash can lose money if they sell their positions, instead of waiting it out for a rise.
- Those who have purchased stock on margin may be forced to liquidate at a loss due to margin calls.
Selling After a Crash
Due to the way stocks are traded, investors can lose quite a bit of money if they don't understand how fluctuating share prices affect their wealth. In the simplest sense, investors buy shares at a certain price and can then sell the shares to realize capital gains. However, if dwindling investor interest and a decline in the perceived value of the stock results in a dramatic drop in the stock price, the investor will not realize a gain.
For example, suppose an investor buys 1,000 shares in a company for a total of $1,000. Due to a stock market crash, the price of the shares drops 75%. As a result, the investor's position falls from 1,000 shares worth $1,000 to 1,000 shares worth $250. In this case, if the investor sells the position, they will incur a net loss of $750. However, if the investor doesn't panic and leaves themoney in the investment, there's a good chance they will eventuallyrecoup theloss when the market rebounds.
Remember—while stock markets have historically gone up over time, they also experience bear markets and crashes where investors can and have lost money.
Buying on Margin
Another way an investor can lose large amounts of money ina stock market crash is by buying on margin. In this investment strategy, investors borrow money to make a profit. More specifically, an investor pools their own money along with a very large amount of borrowed money to make a profit on small gains in the stock market. Once the investor sells the position and repays the loan and interest, a small profit will remain.
For example, if an investor borrows $999 from the bank at 5% interestand combines it with $1 of their own savings, that investor will have $1,000 available for investment purposes. If that money is invested in a stock that yields a 6% return, the investor will receive a total of $1,060. After repayingthe loan (with interest), about $11 will be left over as profit. Based on the investor's personal investment of $1, this would represent a return of more than 1,000%.
This strategy certainly works if the market goes up, but if the market crashes, the investor will be in a lot of trouble. For example, if the value of the $1,000 investment drops to $100, the investor will not only lose the dollar they contributed personally but will also owe more than $950 to the bank (that's $950 owed on an initial $1.00 investmentby the investor).
Margin and The Depression
In the events leading up to the Great Depression, many investors used very large margin positions to take advantage of this strategy. However, when the depression hit, these investors worsened their overall financial situationsbecause not only did they lose everything they owned, they also owed large amounts of money. Because lending institutions could not get any money back from investors, many banks had to declare bankruptcy. In order to prevent such events from occurring again, the Securities and Exchange Commissioncreatedregulations that prevent investors from taking large positions on margin.
By taking the long-term view when the market realizes a loss and thinking long and hard before buying on margin, an investor can minimize the amount of money they lose in astock market crash.
FAQs
Investors who experience a crash can lose money if they sell their positions, instead of waiting it out for a rise. Those who have purchased stock on margin may be forced to liquidate at a loss due to margin calls.
How do investors lose money when the stock market crashes? ›
While it appears that you're losing money during a market crash, in reality, it's just your stocks losing value. For example, say you buy 10 shares of a stock priced at $100 per share, so your total account balance is $1,000. If that stock price drops to $80 per share, those shares are now only worth $800.
Who gets the money when the stock market crashes? ›
The short answer is that the money lost in a stock market crash evaporates. No one gains it.
How do people lose money in the stock market? ›
The first reason people lose money in the stock market is because they try to hand-select individual stocks that they think will be winners. Whether it's because they heard someone on CNBC recommend that stock or because they use the product, investing in individual stocks comes with real risk attached.
What to do when you lose a lot of money in the stock market? ›
How to Recover From a Big Trading Loss
- Learn from your mistakes. Traders need to be able to recognize their strengths and weaknesses—and plan around them. ...
- Keep a trade log. ...
- Write it off. ...
- Slowly start to rebuild. ...
- Scale up and scale down. ...
- Use limit and stop orders.
When the stock market declines, the market value of your stock investment can decline as well. However, because you still own your shares (if you didn't sell them), that value can move back into positive territory when the market changes direction and heads back up. So, you may lose value, but that can be temporary.
Where does all the money go when the stock market goes down? ›
“In other words, the money did not exist or disappear for long-term investors if you did not make any transactions. However, for short-term investors, when stock prices go up or down, the money would be transferred among them as a zero-sum game, i.e. your losses would be others' gains, and vice versa.”
Where is your money safe if the stock market crashes? ›
Where is your money safe if the stock market crashes? Money held in an interest bearing account like a money market account, a savings account or others is generally safe from losses stemming from a stock market decline. Bonds, including various Treasury securities can also be a safe haven.
Where is the best place to put money during a stock market crash? ›
Buy Bonds during a Market Crash
Government bonds are generally considered the safest investment, though they are decidedly unsexy and usually offer meager returns compared to stocks and even other bonds.
Is it better to buy a house when the market crashes? ›
This decreased demand means less competition for homes on the market, which in turn means sellers who are more open to lowering their prices. So buying during a recession, if you are financially able to, may get you a better deal.
1) Preferred Stock
These securities are ideal for investors seeking stable income with less risk than common stocks but more potential returns than bonds. Preferred stocks are often issued by financial institutions and large corporations to raise capital without diluting voting power.
What will happen if the stock market crashes? ›
A stock market crash can result in a bear market, which occurs when the market falls by 10% or more after a correction, for a total drop of 20% or more. A stock market fall might cause a recession. If stock prices fall substantially, corporations will have less capacity to grow, resulting in insolvency.
How to make money when the stock market crashes? ›
Another way to make money on a crisis is to bet that one will happen. Short-selling stocks or short equity index futures is one way to profit from a bear market. A short seller borrows shares they don't already own to sell them and, hopefully, repurchase them at a lower price.
Why do 90% of people lose money in the stock market? ›
Staggering data reveals 90% of retail investors underperform the broader market. Lack of patience and undisciplined trading behaviors cause most losses. Insufficient market knowledge and overconfidence lead to costly mistakes.
Why are my investments losing money? ›
There are several reasons why your investment portfolio may be suffering a loss. It's possible that the market is down. The market can fluctuate based on economic trends, and you may have invested at a time when the market was down. If it continues to stay down, your portfolio will likely lose value as well.
What to say to someone who lost money in stocks? ›
Words like:
- I'm here for you; you're not alone.
- What can I do to help?
- How can I ease your pain?
- I don't know what to say.
- I can't imagine what you're going through.
- You've been through a lot; it's normal to feel angry and upset.
- I'm so happy you're alive and safe.
- I'm here for you if you need to share.
Government bonds and defensive stocks historically perform better during a bear market. However, most people investing for the long term shouldn't be aggressively tweaking portfolios every time there is a sell-off.
What happens to money market funds if the market crashes? ›
Since money market accounts are insured by the FDIC or the NCUA, you cannot lose the money you contribute to the account—even in the event of a bank failure. You can, however, be subject to fees and penalties that reduce your earnings.
What percentage of investors lose money in the stock market? ›
However, data shows us that over 95% of Indian traders are prone to losing money in the markets. A vast majority of traders also tend to stop trading within 1 to 3 years. This all points to one thing — there are some common yet avoidable errors that are pulling the profits down and discouraging aspiring traders.
