Interested in investing in the stock market? As a newbie investor, you might wonder: can you lose more money than you invest in stocks?
As one of the oldest forms of investment, the stock market has thrived for almost 400 years and has grown substantially over time. With the help of technological advancements, investing in the stock market has become increasingly accessible. Investing could be a steady way to build wealth when you’re cautious and know what you’re doing.
When you don’t know what you’re doing, a single wrong move can lead to a complete loss of your investments and, in some cases, even exceed your initial investment.
Let’s look at how you can lose more than your invested amount. Learning the ways of the stock market before investing is very important, and so does knowing about the various accounts and types of trading that you should avoid.
Can You Lose More Money Than You Invest in Stocks?
In most cases, when you invest in stocks, the maximum amount you can lose is the total amount of money you initially invested. The value of stocks can fluctuate, and while there is potential for losses if the stock prices decrease, you cannot lose more money than you initially put into your investments.
This differs from other investment types where losses can exceed the initial investment, such as certain leveraged or borrowed investments. It’s important to research and understand the risks of investing and consider diversification to help manage potential losses.
Ways You Can Lose More Money Than You Invest in Stocks
While you can’t lose money if you invest in the traditional stock market by simply building stocks, there are ways to lose more money than you invest when you’re not careful.
Please read the section carefully to know which investment vehicles to avoid, especially when you have no prior experience.
1. Margin Accounts/Leveraged Trading
Margin accounts are various brokerage accounts that permit you to increase your investment potential by securing loans of up to 50% of your account’s worth from your broker, as per regulatory guidelines. This affords you extra buying capacity to engage in share investments.
A margin account can highly juice up your returns if used carefully. However, with all this comes the risk of greater losses. If things don’t go as expected, you can lose more money than you invest.
Investors who use margin accounts also face a margin call risk, which requires them to deposit cash or sell securities to increase equity if they don’t always maintain at least 25% of the total market value of shares in their margin account. This is a regulation set by the regulatory authority.
Limitations of a Margin Account
- If the declining prices of stocks bring your account value too low, your broker will request you sell your shares or add cash to up the value of your account.
- You must pay your broker interest on the borrowed amount. Those high-interest rates can lower your returns from your trades, eating away at your profits.
- There is added risk when you take up trades with the borrowed amount, and you’ll have to repay your broker regardless of whether your trade was profitable or not.
2. Short Sells
As a user of a margin account, you can short sell a stock when you believe its price will decrease in value. You can take advantage of the market even when the prices of stocks are falling.
A short sell occurs when you borrow shares from your broker to sell them on the open market. Then later, you buy back those shares and return them to your broker. If the price of that specific stock decreases over time, you will earn big profits.
However, in contrast, if prices of that specific stock increase in value over time, you can quickly mount up infinite losses due to margin calls. It can result in losing more money than you invest as short sells also use margin.
3. Options Trading
Stock options are legally binding agreements granting a trader the right to buy or sell a stock at a particular price on or before a chosen date. However, there is no obligation to do so. There are 2 types of options, involving a buyer and a seller.
- Call option
- Put option
The potential for unlimited losses exists exclusively for the seller of call options when the stock price surpasses the strike price (the value at which the option holder can purchase or sell the stock). As a result, a seller of call options could experience greater financial losses than their initial investment.
However, all the other investors in options trading are protected as their losses are limited to either the amount of premium paid for the options or the amount of the strike price.
How To Avoid Losing More Than You Invest in Stocks
A cash account is a prioritized choice for new beginners. However, losing your entire investment is very much possible, depending on the stocks you buy.
A cash account is a brokerage account requiring you to deposit funds from which you can buy shares. You have to pay the entire share amount from your pocket, as you can’t borrow money from the broker with a cash account; hence you only risk what you invest.
You can sell your shares to raise more funds for your cash account, but according to settlement rules, it takes 3 days for a transaction to settle. After that, using those funds to make another purchase will only be possible.
Why You Should Choose Cash
- You can hold a stock as long as you want when you purchase it using cash. You can hold your shares through the highs and lows without being forced to sell if your account value drops too low.
- You cannot lose more than you invest.
- It poses a lesser risk than a margin account.
Limitations of Using a Cash Account
- Short selling a stock is not permitted within a cash account. Short selling involves investors selling stocks they do not possess, anticipating a decline in their value. Subsequently, they repurchase the stock at a reduced price, returning the borrowed shares and profiting from the variance.
- Transaction settlement periods need to be considered when planning and making trades.
Tips and Tricks To Avoid Loss While Trading Stocks
- Invest in a combination of different stocks rather than a single stock. This diversification of investment will reduce the overall investment risk.
- The advisable approach involves maintaining longer-term investments and retaining stocks within the market, prioritizing stability over swift gains. This strategy safeguards your investment and minimizes the impact of minor market fluctuations on your portfolio.
- You should understand your risk tolerance and invest according to how much ability you have to endure the risk of losing your capital.
- Keep monitoring your investment even if you are invested in the market for a longer term. It is very important to monitor regularly and review your assets occasionally, as some stocks can have changed market scenarios over time.
- Steering clear of emotional-driven actions, like making hasty sales or purchases due to panic, can result in unfavorable investment decisions. It is of utmost importance to uphold a composed and logical frame of mind when engaging in trading.
- Implement stop-loss orders to automatically sell a stock when it reaches a predetermined price, limiting potential losses.
- Before investing in a stock, thoroughly research the company’s financials, management, and competitive landscape to make informed decisions.
Frequently Asked Questions (FAQs) – Can You Lose More Money Than You Invest in Stocks?
Is It Normal for Stock Prices To Fluctuate Frequently?
Yes, it is normal for stock prices to fluctuate frequently. That’s why patience is very important when you invest in stocks. Stock prices are determined by the forces of supply and demand in the stock market, and various factors such as market conditions, economic trends, company performance, and investor sentiment can influence these forces, leading to continuous price movements.
Where Can I Find a Company’s Financial Reports and Other Related Information?
You can find a company’s financial reports and related information on its official website under “Investor Relations.” The SEC’s EDGAR system provides access to regulatory filings for U.S. companies. Financial news websites like Yahoo Finance and Bloomberg offer financial statements and key ratios.
Brokerage platforms and data providers like Morningstar also provide comprehensive financial data. Some stock exchanges offer company information. Physical copies of annual reports can be requested from companies. Always verify the reliability of sources before making investment decisions.
Should I Look Forward To Investing in a New IPO (Initial Public Offering)?
Investing in a new IPO is risky and doesn’t promise to be profitable. Investments in an IPO are only advised if they are considered promising and capable. However, some IPOs are worth investing in. Do your own research and know the company you want to buy with the IPO.
Should I Use a Stop Loss on My Investments?
It depends on whether you are a trader or an investor. It is highly recommended that a trader use STOP-LOSS as it can help you prevent many losses. It isn’t recommended if you are a long-term investor, as it might get triggered due to an unusual market fluctuation.
What Kind of Stocks Should I Avoid?
It is recommended to avoid buying stocks with low liquidity. Investors get stuck with stocks that keep losing their own value, but they can’t sell them due to low liquidity, as there are no buyers.
Conclusion – Can You Lose More Money Than You Invest in Stocks?
Investing in stocks comes with both opportunities for gains and risks of losses. While there’s a chance of losing money, historical data shows positive returns in the long term. To make smart investment choices, know your risk tolerance, spread your investments, and think long-term. Remember to seek advice from a qualified financial advisor before making any decisions.
Doing your research and due diligence on how the stock market works will help you avoid making unwise trading decisions or taking reckless risks. It will make your stock investment experience profitable and less stressful.
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Founder of Spark Nomad, Radical FIRE, Journalist
Expertise: Personal finance and travel content
Education: Bachelor of Economics at Radboud University, Master in Finance at Radboud University, Minor in Economics at Chapman University.
Over 200 articles, essays, and short stories published across the web.
Experience: Marjolein Dilven is a journalist and founder of Spark Nomad, a travel platform, and Radical FIRE, a personal finance platform. Marjolein has a finance and economics background with a master’s in Finance. She has quit her job to travel the world, documenting her travels on Spark Nomad to help people plan their travels. Marjolein Dilven has written for publications like MSN, Associated Press, CNBC, Town News syndicate, and more.