What do brokers do with bad stock?

Question

I'm new to financial markets and how they work is still fuzzy, so bear with me. This question actually has multiple questions :( ... and a bit of a story.

I was watching a YouTube video on the history of stock markets and happened to mention the 1920 crash. Apparently the cause of the crash was due to the reason that investors were panicking and thus selling. I didn't think too much on it until my brother mentioned in a discussion that investors selling meant there was a counter party buying.

Since then I have been trying to reason as to when "investors starts to panic and thus start selling".

My guess is that if buying and selling have low volatility or the share prices are fluctuating up and down predictably or is going long then things are grand. But investors start to panic and sell when shares drop below a certain threshold. Maybe prices drop by 5-10%? I dunno..

But then if investors are now going mad in fear and selling like crazy, who buys this bad stocks?

The answer I could come up with are short sellers. So, I'm guessing that short sellers make up the counter party that panicked investors sell their shares to.. otherwise who in their right mind would buy a falling stock?

So the short seller makes a tidy profit and returns the shares to the broker. The broker loses the bet, what does the broker do with these worthless stocks? Can't sell to other investors unless they think the stocks will go long. But let's assume no one thinks the stock will go long anytime soon or that day.

Maybe they can sell to other short sellers? If so, what happens when short sellers "run out"? I'm getting a headache thinking about it.

Answer 1

Market makers, traders, and value investors would be who I'd suspect for buying the stock that is declining. Some companies stocks can come down considerably which could make some speculators buy the stock at the lower price thinking it may bounce back soon.

"Short sellers" are out to sell borrowed stocks that if the stock is in free fall, unless the person that shorted wants to close the position, they would let it ride.

Worthless stocks are a bit of a special case and quite different than the crash of 1929 where various blue chip stocks like those of the Dow Jones Industrials had severe declines. Thus, the companies going down would be like Apple, Coca-Cola and other large companies that people would be shocked to see come down so much yet there are some examples in recent history if one remembers Enron or Worldcom.

Stocks getting delisted tend to cause some selling and there are some speculators may buy the stock believing that the shares may be worth something only to lose the money possibly as one could look at the bankrupt cases of airlines and car companies to study some recent cases here.

Circuit breakers are worth noting as these are cases when trading may be halted because of a big swing in prices that it is believed stopping the market may cause things to settle down.

Answer 2

You have to consider a case where you just cannot sell it. Think of it as a bad piece of real estate in Detroit. If there are absolutely no buyers, you cannot sell it (until a buyer shows up)

Answer 3

For every seller, there's a buyer. Buyers may have any reason for wanting to buy (bargain shopping, foolish belief in a crazy business, etc).

The party (brokerage, market maker, individual) owning the stock at the time the company goes out of business is the loser . But in a general panic, not every company is going to go out of business. So the party owning those stocks can expect to recover some, or all, of the value at some point in the future.

Brokerages all reserve the right to limit margin trading (required for short selling), and during a panic would likely not allow you to short a stock they feel is a high risk for them.