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
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.
How did people lose money during the stock market crash? ›
Among the more prominent causes were the period of rampant speculation (those who had bought stocks on margin not only lost the value of their investment, they also owed money to the entities that had granted the loans for the stock purchases), tightening of credit by the Federal Reserve (in August 1929 the discount ...
Do you lose your money if stock market crashes? ›
Do you lose all the money if the stock market crashes? No, a stock market crash only indicates a fall in prices where a majority of investors face losses but do not completely lose all the money. The money is lost only when the positions are sold during or after the crash.
How can investors lose a profit from stocks? ›
6 Reasons Why Most People Lose Money in the Stock Market
- Individual stock picking. ...
- Having little or no patience. ...
- Trying to time the market. ...
- Following hot stock tips. ...
- IPOs and speculation. ...
- Leverage and margin trading.
“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.”
Who loses money when the stock market crashes? ›
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.
What happened to most people's money when the stock market crashed? ›
Simply put, the stock market crash of 1929 caused the Great Depression because everyone lost money. Investors and businesses both put significant amounts of money into the market, and when it crashed, tremendous amounts of money were lost. Businesses closed and people lost their savings.
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. Tips from famous investors on how to achieve long-term success.
Can a person lose all their money in the stock market? ›
Technically, yes. You can lose all your money in stocks or any other investment that has some degree of risk. However, this is rare. Even if you only hold one stock that does very poorly, you'll usually retain some residual value.
How to make money when the 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.
A risk management principle known as the “3-5-7” rule in trading advises diversifying one's financial holdings to reduce risk. The 3% rule states that you should never risk more than 3% of your whole trading capital on a single deal.
What is the 3 day rule in stocks? ›
The 3-Day Rule in stock trading refers to the settlement rule that requires the finalization of a transaction within three business days after the trade date. This rule impacts how payments and orders are processed, requiring traders to have funds or credit in their accounts to cover purchases by the settlement date.
Do I owe money if stock goes negative? ›
No. A stock price can't go negative, or, that is, fall below zero. So an investor does not owe anyone money. They will, however, lose whatever money they invested in the stock if the stock falls to zero.
Can I lose my IRA if the market crashes? ›
Roth IRAs are not 100% safe, but they offer the potential for growth over time. Market fluctuations and early withdrawal penalties can cause a Roth IRA to lose money. Investing late or contributing too much can also result in potential losses.
What happens if my stock goes to zero? ›
When a stock's price falls to zero, a shareholder's holdings in this stock become worthless. Major stock exchanges actually delist shares once they fall below specific price values.
Who gets the money when stocks fall? ›
When a stock tumbles and an investor loses money, the money doesn't get redistributed to someone else. Drops in account value reflect dwindling investor interest and a change in investor perception of the stock.
Why do people lose money in the stock market? ›
Most people who lose money in the stock market do so through reckless investments in high-risk securities. Although these can score high returns if they are successful, they are just as likely to lose money.
Why did banks lose their money when the stock market crashed? ›
Many smaller banks, such as this one in Haverhill, Iowa, lacked sufficient reserves to stay in business and became no more than convenient billboards. Many of the small banks had lent large portions of their assets for stock market speculation and were virtually put out of business overnight when the market crashed.
How did the stock market crash affect people's lives? ›
Men and women lost their life savings, feared for their jobs, and worried whether they could pay their bills. Fear and uncertainty reduced purchases of big ticket items, like automobiles, that people bought with credit. Firms – like Ford Motors – saw demand decline, so they slowed production and furloughed workers.
What happened to people's money in the Great Depression? ›
Banks failed—between a third and half of all U.S. financial institutions collapsed, wiping out the lifetime savings of millions of Americans. The familiar narrative of the Great Depression places banks among the institutions that suffered fallout from the crisis.
