The Quick Answer: It Depends on Your Account Type
When stocks drop in value, many investors panic and wonder if they’ll end up owing money beyond their initial investment. The short answer? In most cases, no—but there are exceptions.
If you’re investing with a standard cash account, you can only lose what you put in. However, if you’re using margin (borrowing money to invest), you could potentially owe more than your original investment.
Let’s dive deeper into what happens when stocks fall and how different account types affect your potential losses,
Cash Accounts vs. Margin Accounts: Know the Difference
The type of brokerage account you have makes all the difference when it comes to potential losses.
Cash Accounts: Limited Risk
With a cash account, which is what most beginners use:
- You can only invest money you’ve deposited
- Your losses are limited to your initial investment
- If a stock drops to $0, you lose only what you put in
- You cannot owe additional money if stocks decline
As Adam Levy from The Motley Fool explains, “If you’re only using a cash account, your loss is limited to the amount you put in That happens if a stock’s price goes to $0, but that is generally unlikely.”
Margin Accounts: Higher Risk
A margin account lets you borrow money from your broker to buy more stocks
- You can purchase more shares than you could with cash alone
- Your broker typically loans up to 50% of your total account value
- Interest accrues immediately on borrowed funds
- You can lose more than your initial investment
- You may face margin calls if your account value drops below required levels
Here’s a simple example: If you deposit $10,000 in a margin account, your broker might loan you an additional $5,000. You could then purchase $15,000 worth of stocks. But if those stocks drop significantly in value, you’ll still owe the broker the borrowed money, potentially creating a situation where you owe money.
Can Stock Prices Go Negative?
One common question is whether stock prices can go negative. The answer is no.
According to SoFi, “A stock price can’t go negative, or fall below zero. So an investor does not owe money. They will, however, usually lose whatever money they invested in the stock if the stock falls to zero, especially as the company may declare bankruptcy.”
The lowest a stock can go is $0, which happens in cases of bankruptcy or complete business failure.
When Might You Owe Money When Stocks Decline?
There are specific scenarios where you might owe money when stocks drop:
1. Margin Calls
If you’re trading on margin and your account value falls below the required maintenance level (typically 25% of total securities value), your broker will issue a margin call. This requires you to:
- Deposit additional cash
- Deposit additional securities, or
- Sell some of your holdings
If you don’t respond to the margin call, your broker may liquidate your positions to cover the shortfall, potentially at unfavorable prices.
2. Short Selling Gone Wrong
When you short sell a stock, you’re essentially betting that its price will fall. You borrow shares from your broker, sell them, and hope to buy them back later at a lower price.
However, if the stock price rises instead, you’ll have to buy back shares at a higher price than you sold them for. Since there’s no theoretical limit to how high a stock can go, your potential losses are unlimited.
3. Options Trading
Certain options strategies can expose you to significant losses. For instance, selling uncovered call options can lead to substantial losses if the underlying stock rises dramatically.
Real-Life Example of Margin Risk
Let’s look at a practical example:
Imagine you buy a stock for $100 using 50% margin. You put in $50 of your own money and borrow $50 from your broker.
If the stock drops to $40, you still owe your broker $50, but selling the stock only raises $40. You’ll need to pay an additional $10 out of pocket to cover the loan.
What Happens When a Stock Goes to Zero?
When a stock’s price falls to zero, the company has usually:
- Filed for bankruptcy
- Had its assets liquidated
- Been delisted from stock exchanges
For investors using cash accounts, you simply lose your investment. But for margin traders, you’ll still owe whatever you borrowed, even though your investment is worthless.
Warning Signs a Stock Might Fall to Zero
Not all declining stocks will hit zero, but here are red flags that might indicate serious trouble:
- Persistent revenue or earnings losses
- Management scandals or fraud allegations
- Major industry disruptions
- Heavy debt loads
- Declining market share
- Investigations by regulatory agencies
Protecting Yourself From Significant Losses
Even though we can’t predict the market perfectly, here are strategies to help protect your investments:
1. Use Stop Loss Orders
A stop loss order automatically sells your shares if the stock falls to a predetermined price. This can limit your losses if a stock begins to plummet.
2. Diversify Your Portfolio
By spreading your investments across different stocks, sectors, and asset classes, you reduce the impact any single investment can have on your overall portfolio.
3. Avoid Excessive Leverage
Be cautious with margin trading. Many financial advisors recommend that beginners avoid margin altogether until they gain more experience.
4. Research Before You Invest
Do your homework before buying stocks. Look at the company’s financial statements, business model, competitive position, and growth prospects.
5. Consider Index Funds for Lower Risk
Index funds provide instant diversification and typically carry lower risk than individual stocks.
Types of Stocks More Likely to Fall to Zero
Some stocks carry higher risk of falling to zero than others:
Penny Stocks
Stocks trading under $5 (penny stocks) often represent companies with weak fundamentals and higher volatility.
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.
Highly Leveraged Companies
Companies with excessive debt may struggle to stay afloat during economic downturns.
Famous Examples of Stocks That Fell to Zero
Enron
In the 1990s, Enron’s stock traded above $90. After accounting fraud was revealed in 2001, the stock plummeted to $0.26 before bankruptcy.
WorldCom
This telecom company’s stock fell from over $60 to less than $1 before declaring bankruptcy in 2002 after massive accounting irregularities were discovered.
Frequently Asked Questions
Can I go into debt from stock market losses?
With a cash account, no. You can only lose your initial investment. With margin accounts, short selling, or certain options strategies, yes—you can potentially owe money.
How low can a stock go before being removed from exchanges?
Major exchanges have minimum price requirements. For example, the New York Stock Exchange will delist a stock if its price remains below $1 for 30 consecutive trading days.
What happens to my shares if a company goes bankrupt?
In bankruptcy, shareholders usually lose their entire investment. Creditors, bondholders, and preferred shareholders get paid first from any remaining assets, with common stockholders last in line.
Is buying a falling stock (“buying the dip”) a good strategy?
It depends. For quality companies experiencing temporary setbacks, buying during price dips can be profitable. But for companies with fundamental problems, catching a “falling knife” can lead to further losses.
Bottom Line: Cash Accounts Provide Peace of Mind
For most individual investors, especially beginners, cash accounts offer the safest approach to stock investing. You can’t lose more than you put in, which provides peace of mind during market volatility.
If you’re considering using margin, short selling, or options, make sure you fully understand the risks involved and have a solid risk management strategy in place.
Remember, the stock market offers no guarantees. While the long-term trend has historically been upward, individual stocks can and do fail. Diversification, research, and risk management are your best tools for navigating the ups and downs of the market.
By staying informed and making prudent choices, you can pursue growth while protecting yourself from the worst-case scenarios that make investors lose sleep.
