Where does the money go when the stock market crashes

The stock market is crashing. Online and offline media are filled with catchy headlines that read: S&P has lost a third of it's market value over the past month. or Market Cap of XYZ company cut in half and so on...

You ask - where does all the money go ?

Short answer: the money doesn't go anywhere when the market crashes, mainly because it was not there to begin with!

Let me try to explain in really simple terms. The current stock price of XYZ company is what one buyer is willing to pay one seller for that specific trade. That buyer thinks the price is a reasonable amount to pay and that seller thinks it's a good price to sell his/her shares at.

Market cap of a stock is defined as: stock price multiplied by total number of outstanding shares. For example, let's assume XYZ company has 1 million outstanding shares. So, when one buyer purchases 10 shares from one seller at a price that's one dollar higher than the current price, the market cap of XYZ increases by $1 million, by definition. Really? How can a transaction that involves a measly 10 shares increase the value of a company by a million dollars? Where did that money come from? Similarly, when a seller decides to get rid of 10 shares at a price that's two dollars less than current price, the market cap of XYZ falls by $2 million. Where did that much money go? As you can see, one million dollars were not gained when the stock price went up, and by the same token, 2 million dollars were not lost when the shares fell in price. Hope this answers your question.

You ask further - really, did no one lose money when the stock market crashed?

Answer: Yes and No. Yes, some folks did lose money when the stock market crashed. Those are investors who purchased shares of XYZ at $100 and sold at $80 when the prices fell. (Hope you are not one of them!) No, those who held onto their shares did not lose real money, they just lost money on paper. Say, for example, the stock market recovers after six months and the price of XYZ rises to $110. Those folks who held onto their shares when the price fell to $80 can now sell at $110 for a real profit of $10 per share.

In summary, you lose real money in a stock market crash only if you sell any of your shares at a price lower than what you purchased them for. If you don't need the money right away and if you are patient enough to hold onto your shares, you can potentially sell the shares later at a higher price than you purchased them for.

Next Steps:

  • There are many alternatives to stock market that are low risk, and yet provide decent returns.
  • Stocks are still a very good way to increase your net worth. Here's a low risk way to dabble in stocks by trading with a little bit of Professional Help. While this is not free, the subscription fees would usually pay for itself in just one trade. Learn about a unique way to profit from the familiar Professional face on TV, Jim Cramer.
  • Though patience sometime pays off for some stocks, it may not always be the best choice. Going with the flow, otherwise known as Trend Trading, is one of the ways to avoid a stock market crash. See how running away from stock market at the right time can be beneficial to your portfolio.

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