As any long-term investor in the market can attest, stocks rise and fall-influenced by a meandering mix of human psychology, economic trends, and supply and demand.
The value of stocks, in other words, is never etched in stone. Besides investors' continued willingness to put their money into a specific company, there's no one thing that makes a stock's value keep going up.
Given the inherent volatility of stock values, there are periods when the market is down (and times when it's gaining steam). So, how low can a stock go? Well, in some cases, stock prices can fall the way to zero.
Watching stocks in free fall can induce fear and panic in investors, causing some to sell their holdings. While most every investor aims to buy low and sell high, timing the stock market is very challenging and doesn't guarantee investors will see gains.
(Many investors sell stocks when the market is plunging to prevent further losses, but this isn't necessarily the best decision.)
Sometimes when a stock goes down in value it can present an investment opportunity, but in other cases the stock could fall to zero and never recover. In the later case, it may behoove investors to sell before the stock price falls all the way down to zero.
Here's an overview of what happens when a stock's value falls to zero, including some ways to stop a holding that's spiraling downward.
Related: What is modern portfolio theory?
What causes a stock to fall to zero?
When a stock falls to zero, it doesn't mean that the company is, objectively, worth nothing. Some companies with very low stock values are still earning money (or possess assets). And, some investors buy penny stocks that have extremely low prices.
If a company continuously spends more money than it earns, and investors sell off the stock, ultimately that can lead to the company going bankrupt. Most companies file for either Chapter 7 or Chapter 11 bankruptcy before their stock reaches $0.00.
Below is a summary of the difference between Chapter 7 and Chapter 11 bankruptcies.
Chapter 7 bankruptcy
With a Chapter 7 bankruptcy filing, the company for it must sell off its assets until it can repay lenders and creditors. The order that stakeholders get paid is as follows: creditors, bondholders, preferred stockholders, common stockholders.
This means that if the asset sale doesn't bring in enough money to pay everyone, it's likely that common shareholders won't receive a dime. In this case, stockholders lose all the money they had invested in that stock.
Under Chapter 7, stock trading and all business activities must be put on hold.
Chapter 11 bankruptcy
Under a Chapter 11 bankruptcy, however, the company negotiates loan terms with its creditors in order to avoid selling off assets. With Chapter 11, companies can still conduct business and their stock can be traded.
Once a company files for Chapter 11, it is likely that the stock will continue to fall, since many investors won't have much faith in the business. Sometimes, shares are canceled with a Chapter 11 filing-in which case, investors lose all the money they had put into the stock.
Even if a company files for bankruptcy before its stock falls to zero, their attempts to salvage the business may ultimately fail and the stock could become worthless. However, it can take a strong team and business model to go public and get listed on stock exchanges in the first place, so bankrupt companies do have the potential to make a comeback.
Some companies with very low stock prices get acquired by larger companies before their stock falls to zero. Even a company with a low stock might have a promising product or service that a larger company is able to successfully sell. One example of this in recent memory is when Alphabet acquired FitBit.
What happens to stocks that fall to zero?
Some stock exchanges delist stocks if they fall below a certain level. For example, the New York Stock Exchange will remove a stock if its share price falls below $1 for 30 days in a row.
And, as mentioned above, if a company files for Chapter 7 bankruptcy, its stock will be delisted temporarily.
If a stock gets delisted, it generally can still be traded on an "over the counter" market, but these are not easily known or accessible to most investors.
It's not possible for a stock's price to go negative.
Fortunately, it is not possible for a stock's price to go into the negative territory-under zero dollars in value, that is.
Still, if an investor short sells or uses margin trading, they may nevertheless lose more than they invested. For this reason, margin trading and short selling are risky investment strategies.
Short selling is when an investor predicts that a stock is going to decrease in value. So, rather than buying the stock, they 'bet' that it will go down. If the stock does in fact go down, they make money.
But, if the stock ends up increasing in value, they lose money. Potentially, an investor in this scenario could lose more money than they put into the initial short sell.
Margin trading is when an investor borrows money from the brokerage firm to trade stocks. If the investor makes a trade that doesn't go in their favor, they can end up owing the brokerage firm money.
If a company goes bankrupt and an investor has a margin trade in place (and no margin account debt), they will almost never owe any money.
Types of stocks likely to fall to zero
Every stock comes with risks, but some are more risky than others. Besides companies on the brink of bankruptcy, there are other types of businesses that have a higher chance of becoming worthless.
Knowing what to look for and researching stocks before buying is key to building a resilient portfolio. Some of these higher risk stocks might include:
Companies with weak business models
Even if a stock is currently performing well, it may fall in the future if the business model is fundamentally flawed. For this reason, many investors prefer to research a company's practices, team composition, and business model before investing in its stock.
Penny stocks
Stocks that trade below $5 are known as penny stocks. These low price stocks tend to be very volatile, as the companies that issue them have low or no profit.
Sometimes penny stocks can turn out to be scams or pump and dump schemes, which end up completely worthless.
Buying the dip
Rather than selling stocks when the market declines, some investors believe it can be a good idea to buy while the market is low. By buying the dip, investors pay less for stocks.
By buying the dip, investors pay less for
stocks.
And, since these stocks still have the potential to go up in value as the market recovers after the decline, they can be preferred by long-term investors. After all, they may have more time to let their portfolio go back up in value over time.
However, if a company is going bankrupt or otherwise likely to fall to zero, it's unlikely to offer a strong return on investment.
It's also very difficult to time the market, so a trader might buy in when they think the market has hit bottom, only to watch it continue to go down.
Generally, building a diversified, long-term portfolio can offer higher returns on average over time than trying to time the market based on shorter-term trends or dips.
How to prevent holding a stock that's falling lower
While it's true that the market is impossible to predict, there are some measures that investors can take to protect themselves from losses-especially in the case of a stock spiraling towards zero.
By setting up a stop loss sale, for instance, investors could automatically exit a position at whatever threshold they choose. Below is an overview of some common, preventative investment measures:
Stop losses
Investors can set up a trade to automatically sell shares, if a stock reaches a specific price. This type of trade is called a stop loss. It's a strategy that could help prevent losses in the case of an individual stock or overall market drop.
There are multiple types of stop losses, including trailing stops and hard stops. Trailing stops move the stop level up as the stock rises in value, but stay in place if the stock falls. Hard stops are fixed at a specific price and will execute if the stock falls to that price.
Limit orders
Limit orders allow investors to set the price at which they want to buy a stock. An investor selects the price and the number of shares they wish to buy. In practice, the order only executes if the stock then hits that price.
This is one way for traders to step away without worrying that they'll be buying in at a price they didn't want.
Put options
A put option is a type of order that gives traders the option to sell or short-sell a specific amount of stock at a specific price, within a certain time frame. If a stock decreases in value in this case, the trader can still sell it at a higher price than it previously held.
Diversifying asset holdings
In an effort to prevent losses, some investors may want to diversify their portfolios into a mix of non-correlated assets-dividing their holdings between assets at a higher and lower risk of fluctuating in value.
In a diversified portfolio, should one asset class decrease in value, the other types may not. Over time, the ups and downs of each asset could possibly balance the losses in each.
Setting up a stock portfolio
By researching companies and setting up a portfolio according to one's personal risk tolerance, it's possible to hedge against a stock sinking down to zero.
But, not all investors know what to look for in a stock when picking which securities to buy. Digital investing tools can help investors keep track of stocks.
More from SoFi:
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
SoFi Invest
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual's specific financial needs, goals and risk profile. SoFi can't guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term "SoFi Invest" refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Automated Investing
The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor ("SoFi Wealth"). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA / SIPC , ("SoFi Securities").
Third Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third party trademarks referenced herein are property of their respective owners.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.