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Trading in stocks can earn you lots of money, as evidenced by the countless investors who have made a name for themselves in the stock market. However, this dynamic market is also susceptible to various factors that cause stock prices to rise and fall, which might make you wonder, can you get negative money in stocks?
You cannot have negative money in stocks because even if the price of your stocks fluctuates or falls drastically, it cannot attain a value less than zero. However, while this cannot happen, the book value can go negative, and you can lose more money than you invested or end up in debt.
Losing money in the stock market happens quite often. Read on to learn the circumstances under which you can lose money in stocks and how to avoid falling victim.
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How Does a Stock’s Value Get to Zero?
A stock's value can go as low as zero if the company goes bankrupt. If there are no funds to pay off creditors, the stockholders receive zero compensation for their shares. In other words, their stock becomes worthless, and they lose their entire investment.
Which Stocks are Risky to Invest in?
While stocks are risky in general, stocks from poorly managed companies and penny stocks are particularly high-risk. You can lose a great deal of money shorting a company you think is doomed.
While your investment in penny stocks may skyrocket, it can plummet back down just as quickly.
Penny stocks or stocks that sport an extremely low price are subject to high levels of volatility. Traditionally, these were $1 stocks, though, with today's classification, any stock trading below $5 falls in this category.
Penny stocks trade on the OTC markets or pink sheet system, but the issuing companies have insignificant profits. Furthermore, they are prone to scams, and their value is likely to fall to zero or close.
Stocks From Poorly Managed Companies
If a penny stock issuing company has a poor business model, its stock price can dip to near-zero levels. The same case can also occur if a company goes bankrupt. Therefore, it's crucial to understand a company's business and how it works before investing in it.
Still, stock prices don't necessarily fall to zero even when a company goes bankrupt because the company still retains some value. Also, stock exchanges typically delist low-trading shares before they get to zero levels or when they trade below $1 for 30 days.
Most firms with low stock prices opt for a reverse stock split whereby they lower their outstanding shares through consolidation.
Can You Lose More Money Than You Invested?
You can lose more money than you invested while trading on margin or going short. When margin trading you can lose money as the stock declines, and with short selling you lose money as the stock appreciates.
Let's take a closer look at the two instances.
When Trading on Margin
Margin trading happens when you buy a stock with money borrowed from your broker to complement your own, thus leveraging your trade. This leverage can go up to 1:2, depending on what percentage of the trade comes from your money.
However, you can only trade on margin if you are operating a margin account rather than a cash one.
When you trade using borrowed money, you multiply the losses you make by the leverage. What's more, you not only lose your money, but the broker's too, which could translate to losing more money than you invested.
When Going Short
A short sale occurs when you borrow a stock or the funds to purchase it from a broker with a sell order, i.e., an obligation to repurchase the stock in the future.
You can also lose more funds than you invested if you go short on the stock and it suddenly shoots up by over 100%. This is particularly so if you happen to take a short position on a stock from a company that is not performing well.
The short sale technique relies on the premise that the stock price will fall. However, when the reverse happens and the stock price rises, you stand to lose more than your initial investment since you'd have to repay the money you had borrowed.
What Determines the Value of a Stock?
Investor perception, supply and demand, and a company’s earnings can all determine and affect the value of a stock. When a stock has positive perception from investors, is in demand, and has successfully turned profit in previous years, the share price is likely to increase.
Investor perception determines the price of a given stock. When investors consider the share value to be low, the share prices fall. What's more, investors feel that the stock price reflects a company's current value as well as the expected future growth.
Nevertheless, while a stock's price movements show what investors believe to be the company's worth, its value is not the same as its stock price. Rather, a company's value refers to its market capitalization.
Supply and Demand
Supply and demand also affect stock prices. When more investors desire to acquire (demand) a particular stock than those looking to sell it (supply), the share price rises.
But if the opposite happens and more individuals seek to sell the stock than buy it, the price falls since the supply becomes greater than the demand.
A Company’s Earnings
This is a major factor that affects the value of a company. If a company fails to turn a profit, it cannot survive for long. To this effect, public companies must report their quarterly earnings.
Financial analysts base their company valuations on such reports as well as earnings projections.
When a company's results come out better than predicted, the share price moves up. However, if the results fall short, then the share price plummets.
Ways to Protect Your Money
While a number of regulations exist to protect investors from losing more money than they invested through frivolous borrowing, it can still happen. This is because markets are uncertain.
Fortunately, there are ways to protect your money from the effects of negative price movements. Some of the most effective ones include:
- Using a stop loss order. Stop loss orders protect your trades from unfavorable price movements by placing a cap on the amount you can lose. For instance, a trailing stop order moves alongside a progressing stock price but remains at the highest level attained when the price starts to fall.
- Diversifying your stock portfolio. Diversifying your stocks helps minimize the risk posed by owning a single stock or select stocks from within the same industry. It helps spread the risk across a mix of investments, thus minimizing your chances of losing everything. You can diversify by purchasing stocks from various industry sectors, buying an index fund, or other assets such as real estate, dividend stocks, government bonds, and commodities.
- Consider long-term investing. Some investors prefer day trading, but while it has its appeal, long-term investing can help your investments flourish. This is because you can ride out any market dips that might occur.
- Have a well-thought-out investment plan. When investing, start by considering how much to invest and how much risk you are willing to take, given the possibility that your money might reduce in value. Always avoid over stretching yourself and carefully weigh the risks against potential rewards.
Stock prices can change swiftly, and though investors can use charts or study past price movements, it's not always possible to predict the exact price movement - or the optimal time to buy and sell.
Still, even during extremely volatile price changes, the stocks cannot reach a negative value.
Furthermore, if you're trading with your own money without using sophisticated techniques, then you are highly unlikely to lose more than your investment. This remains true even if the company you invest in goes bankrupt, as the value of its shares will merely drop to zero.
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