this post was submitted on 07 Jan 2024
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Isn't there normally collateral you put in and then if it goes up too much your collateral gets liquidated, but that's the end of it? It is definitely at least possible for your maximum losses to have a cap when shorting.
You can auto buy the stock if it goes above a certain price, so you can effectively cap it. But if there is a short squeeze, and not enough sellers, the price of the stock can rise very quickly and you would risk bankruptcy.
As the price of the stock rises, your collateral price is required to rise as well to maintain the short position, but if there isn't enough supply of stocks to meet the demand, you're still in trouble.
If there is a stock that many people decide to hold a short position against, there is a bigger risk for a squeeze...
If you're going to short a stock, you better really really know what you're doing, otherwise you're putting yourself at an unnecessary risk for a not so great reward. If any of my friends told me they are considering shorting a stock, I would do my best to diswage them from doing so.
I am really skeptical that this is how it works, like if such a rapid rise happens someone is really going to go through a legal proceeding against thousands of retail investors individually to collect money they may or may not have? Seems more likely that the possibility is accounted for by the loan being virtual in some sense, the exchange holding the ultimate legal responsibility, and compensating with an extra penalty if you hit the liquidation number and insurance.
I'm not an expert by any means, but the risk is real... Especially if you buy many stocks, it can bankrupt you very quickly. And shorting has a limit to how much return it can yield. If a stock is worth $10, and it goes to zero, your profits are $10. You can't make more than that, so an investor who wants to make money by shorting the stock will probably hold a short position on a large quantity of these stocks. So then, if you are shorting 100 stocks of $10, and the stock climbs to $50, you're going to have to buy $5000 worth of stocks, so your net loss is $4000.
There are too many cases of people losing lots of money by shorting a stock, even large investment firms had to beg for a bailout on occasion after a big short squeeze. For the most part you can mitigate risks, but it still has a higher risk than other forms of investment.
Recent examples of it was TESLA and GameStop... People shorting TSLA stocks lost 40B, and the GME short squeeze ended up with 6B loss.
The GameStop stuff illustrates exactly what I'm talking about here though, all those people on Robinhood getting force-sold because their ownership of stocks was virtual and the ones actually on the hook to finalize things were the exchange's creditors.
Naturally for a big player putting billions on something they are going to be doing it directly and thus have full legal liability and unlimited potential losses like you say, but I expect losses are probably limited to the collateral amount for regular people in most circumstances, because otherwise it would be a ridiculous mess for the party providing the loans to them.