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Sunday, December 9, 2012 - Page updated at 07:30 p.m.
Coming to terms: Forced selling
Q: What’s “forced selling”?
A: Forced selling can happen when the market tanks, and it can make things worse because once it starts, it tends to snowball.
Imagine you own shares of a mutual fund that has fallen sharply in value. It’s often best to just hang on, waiting for a recovery — provided you still have faith in the managers.
But many shareholders will bail out, in fear or anger. When they do, the managers have to sell off some of the fund’s holdings to generate the cash needed for withdrawals.
When many funds are selling lots of stocks, that can further depress the stocks’ prices.
This can then cause more investors to sell, putting more pressure on stocks. It’s frustrating for fund managers because while they may see lots of bargains, they’re forced to sell, not buy.
Meanwhile, other investors may have bought stocks “on margin” — i.e., with borrowed money. If those stocks fall sharply, those investors will need to put in more money or sell. Many will sell, exacerbating the problem.
The Motley Fool