Sunday, June 27, 2010

Where did all the money go???

We've seen the markets rise and fall all over again. Sometimes I've asked myself a question : ' When the prices fall, where does all the money go?' I could imagine that 'smart money' left first and somebody made a huge profit (just like in any pyramid scheme). Never really got the time to think about it, until today. Today somebody asked me this question and while trying to explain it all suddenly became clear. The 'money' was never really there. A good illustration are the house prices. Imagine you bought a house for $500k a couple of years ago. The prices have risen since then to 550k, so you've made a virtual profit of 10%. Now the prices fall again and you start loosing 'virtual' money. This is the same as unrealized pnl. The good thing with real estate is that they have some real underlying value, while for the stocks the underlying value is often completely unclear.

1 comment:

  1. It is certainly true with regards to real estate, though probably less so with the equity markets. The real-estate market tends to become less liquid as valuations fall.

    With the equities markets, a good % of price movements in liquid stocks have an accompanying trade in both advancing and declining markets. This implies that there is a winner and a loser at some point in the stock's fall.

    Of course with a declining stock, both buyer and seller can be losers depending on the holding period and cost basis. There is also the observation that declines tend to gap. With a gap there is little or no trade action, just a near instantaneous price adjustment downward.

    So I almost agree with you in that there is probably more profit accumulated in being long in an advancing market than made in a declining one, due to the difference in price action.