When Stock Prices Drop, Where's the Money?

QUOTED from BB investing notes Blogsite

When Stock Prices Drop, Where's the Money?

by Investopedia Staff
Monday, March 16, 2009

Have you ever wondered what happened to your socks when you put them into the dryer and then never saw them again? It's an unexplained mystery that may never have an answer. Many people feel the same way when they suddenly find that their brokerage account balance has taken a nosedive. So, where did that money go? Fortunately, money that is gained or lost on a stock doesn't just disappear. Read to find out what happens to it and what causes it.

Disappearing Money

Before we get to how money disappears, it is important to understand that regardless of whether the market is in bull (appreciating) or bear (depreciating) mode, supply and demand drive the price of stocks, and fluctuations in stock prices determine whether you make money or lose it.

So, if you purchase a stock for $10 and then sell it for only $5, you will (obviously) lose $5. It may feel like that money must go to someone else, but that isn't exactly true. It doesn't go to the person who buys the stock from you. The company that issued the stock doesn't get it either. The brokerage is also left empty-handed, as you only paid it to make the transaction on your behalf. So the question remains: where did the money go?

Leno's Response ~

This is an example of simple things are perceived wrongly or at least i will csaid "mal-represented." The answer or explanation lies firstly by re-correcting the "mal-representation," or simply re-stated the whole perception from the beginning.

When I bought a "second-hand" car from someone (similar as stocks which are traded thru secondary market), I will pay a certain amount for eg. RM 20,000 to Abu. Now, i am less RM 20,000 in my bank or just let presume my bank balance left zero after witdrew to pay Abu, in exchange for the ownership of the "CAR."

If another car of the same type is transacted at RM 15,000, let's say in between Ah Chong and Ramasamy, could we safely presumed my car has depreciated by RM 5,000 ?

If another car of the same type is transacted at RM 25,000 again between others buyer and seller, could I say, "WHOA ! I just made RM 5,000 !" ?

Funny right ? Of course by now, someone will try to educate me about the so-call "paper" loss or gain.

Now, let's say I sell-off my Car at RM 15,000 to Jay. Therefore Jay will have "less RM 15,000" by owning the car, Abu (the one who sold the car to me at the first place) still holding RM 20,000 but with no car and, I will have RM 15,000 and car-less as well.

Let's rephrase whole scenario using a table

Previously,
Abu got 1 car / RM 0 cash
I.. got 0 car / RM 20,000 cash
Jay got 0 car / RM 15,000 cash
_______________________________
total...1 car / RM 35,000 cash

Later
Abu got 0 car / RM 20,000 cash
I.. got 1 car / RM 0 cash
Jay got 0 car / RM 15,000 cash
________________________________
total...1 car / RM 35,000 cash

Now
Abu got 0 car / RM 20,000 cash
I.. got 0 car / RM 15,000 cash
Jay got 1 car / RM 0 cash
________________________________
total...1 car / RM 35,000 cash

The car and the cash are just shifting between the 3 of us.
The total cash remain the same at RM 35,000.
I have less RM 5,000 but could we said Abu had earned RM 5,000 from me ?

There is no FINAL answer until we truly figure out the true value of the car.

What if Jay found RM 100,000 cash inside the car drawer ? Obviously, both,Abu and I just missed or actually LOSS the RM 100,000 to Jay !
What if the car totally "unrepairable" broke down forever, just 1 day after Jay bought it ? Wow ! Now I just earn RM 15,000 evernthough i have less RM 5,000 from my initial RM 20,000 bank balance ?

The moral will come back the same. Transacted price tell us not much. Sooner or later, it is the "true" value of the car that determined who make or who lose what.
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Getting more Confused ?
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