A:

First, a quick review of stock basics: owning a stock means owning a portion (usually very small) of a 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 amongst any parties; the value of the company simply shrinks. The stock market is governed by the forces of supply and demand. In other words, 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.

Let's look a little closer at how a company's value can simply 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 a low demand in relation to supply. Just as a high number of buyers creates value, a high number of sellers erodes 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 realized 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.

For more on this subject, check out Missing Money, Missing Socks? Coincidence?

RELATED FAQS
  1. Can a stock lose all its value? How would this affect a long or short position?

    The answer to the first part of this question is pretty straightforward: yes, stocks are able to lose all their value in ... Read Answer >>
  2. When does a growth stock turn into a value opportunity?

    Learn how fundamental analysts use valuation measures, such as the price-to-earnings ratio, to identify when a growth stock ... Read Answer >>
  3. What is the difference between intrinsic value and current market value?

    Discover the differences between intrinsic and market values, what makes the former difficult to determine and how investor ... Read Answer >>
  4. How can you calculate the difference between nominal value and real value of stock ...

    Explore the impact of real value and nominal value on stock trading. Find out how these values are assigned and what causes ... Read Answer >>
  5. What is the difference between book value and market value

    Learn the differences between book value and market value, and see how investors use each type to determine if a company ... Read Answer >>
  6. How does the law of supply and demand affect the stock market?

    Find out how the law of supply and demand affects the stock market, and how it determines the prices of individual stocks ... Read Answer >>
Related Articles
  1. Options & Futures

    Stock-Picking Strategies: Value Investing

    Value investing is one of the best known stock-picking methods. In the 1930s, Benjamin Graham and David Dodd, finance professors at Columbia University, laid out what many consider to be the ...
  2. Investing Basics

    Stocks Basics: What Causes Stock Prices To Change?

    Stock prices change every day as a result of market forces. By this we mean that share prices change because of supply and demand. If more people want to buy a stock (demand) than sell it (supply), ...
  3. Investing Basics

    How The Stock Market Works

    When you buy a stock, you buy a piece of a company.
  4. Fundamental Analysis

    Value Investing Strategies in a Volatile Market

    Volatile markets are a scary time for uneducated investors, but value investors use volatile periods as an opportunity to buy stocks at a discount.
  5. Active Trading Fundamentals

    Five Minute Investing: Replacing Stock Market Myths

    In the introduction to "Five Minute Investing", I mentioned that the ideas and approaches developed in this book would be unorthodox. In this chapter, I hope to point out and correct a few of ...
  6. Active Trading

    Value Investing: What Is Value Investing?

    Unlike some investment strategies, value investing is pretty simple. It doesn't require that you have an extensive background in finance (although understanding the basics will definitely ...
  7. Investing Basics

    Explaining Market Value of Equity

    Market value of equity is the total value of all the outstanding stock as measured in the stock market at a particular time.
  8. Active Trading

    Value Investing: Finding Undervalued Stocks

    There are two basic steps to finding undervalued stocks: developing a rough list of stocks you want to investigate further because they meet your basic screening criteria, then doing a more in-depth ...
  9. Fundamental Analysis

    The Market Value Versus Book Value

    Understanding the difference between book value and market value is a simple yet fundamentally critical component to analyze a company for investment.
  10. Savings

    Teaching Financial Literacy To Tweens: The Stock Market

    Introducing kids to the stock market and the concept of investing is an excellent way to set them on a path for future earnings.
RELATED TERMS
  1. Value Investing

    The strategy of selecting stocks that trade for less than their ...
  2. Relative Value

    A method of determining an asset's value that takes into account ...
  3. Market Value

    The price an asset would fetch in the marketplace. Market value ...
  4. Market Value Of Equity

    The total dollar market value of all of a company's outstanding ...
  5. Stated Value

    A value that, instead of being par value, is assigned to a corporation's ...
  6. Large-Value Stock

    A type of large-cap stock investment where the intrinsic value ...

You May Also Like

Hot Definitions
  1. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  2. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  3. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  4. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  5. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
  6. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
Trading Center