Can a stock lose its value? The answer to this question is pretty straightforward: Yes, stocks are able to lose all their value in the market. Now, we don't want to scare you off investing in stocks, or investing in general. However, we would be lying if we claimed that stocks carry no risk (although some carry more than others).
- Supply and demand determine the value of a stock, with higher demand driving the price higher in turn.
- Lower demand causes a stock to lose some value—and plummeting demand could cause it to lose all value.
- In trading, a drop in stock value is a boon to investors who are trying to short a stock and a calamity to those who are holding long positions and hoping a stock price will rise.
Determining Stock Price
To help you understand why a stock can lose all its value, we should review how the stock price is determined. Specifically, the value of a stock is determined by the basic relationship between supply and demand. If a lot of people want a stock (demand is high), then the price will rise. If a lot of people don't want a stock (demand is low), then the price will fall.
If a stock's demand sinks dramatically, it will lose much (if not all) of its value. The main factor determining the demand for a stock is the quality of the company itself. If the company is fundamentally strong, that is, if it is generating positive income, its stock is less likely to lose value.
So, although stocks carry some risk, it would not be accurate to say that a loss in a stock's value is completely arbitrary. There are other factors that drive supply and demand for companies.
Companies that are fundamentally strong are less likely to completely lose value than those that are on shakier legs, to begin with.
Impact on Long and Short Positions
The effects of a stock losing all its value will be different for a long position than for a short position. Someone holding a long position (owns the stock) is, of course, hoping the investment will appreciate. A drop in price to zero means the investor loses his or her entire investment – a return of -100%.
Conversely, a complete loss in a stock's value is the best possible scenario for an investor holding a short position in the stock. Because the stock is worthless, the investor holding a short position does not have to buy back the shares and return them to the lender (usually a broker), which means the short position gains a 100% return. Bear in mind that if you are uncertain about whether a stock is able to lose all its value, it is probably not advisable to engage in the advanced practice of short selling securities. Short selling is a speculative strategy and the downside risk of a short position is much greater than that of a long position.
To summarize, yes, a stock can lose its entire value. However, depending on the investor's position, the drop to worthlessness can be either good (short positions) or bad (long positions).