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Risks of Short SellingRisks of Short Selling

Unlike long transactions (i.e., buying shares or other instruments), short selling involvesUnlike long transactions (i.e., buying shares or other instruments), short selling involves

significant costs, in addition to the usual trading commissions that have to be paid on stocksignificant costs, in addition to the usual trading commissions that have to be paid on stock

transactions. These include:transactions. These include:

Margin interestMargin interest – Margin interest can be a significant expense when trading stocks on – Margin interest can be a significant expense when trading stocks on

margin. Since short sales can only be undertaken in margin accounts, the interestmargin. Since short sales can only be undertaken in margin accounts, the interest

payable on short trades can add up over time, especially if short positions are kept openpayable on short trades can add up over time, especially if short positions are kept open

over an extended period.over an extended period.

Stock borrowing costsStock borrowing costs – Shares that are difficult to borrow – because of high short – Shares that are difficult to borrow – because of high short

interest, limited float, or any other reason – have “interest, limited float, or any other reason – have “hard-to-borrowhard-to-borrow” fees that can be” fees that can be

quite substantial. This fee is based on an annualized rate that can range from a smallquite substantial. This fee is based on an annualized rate that can range from a small

fraction of a percent to more than 100% of the value of the short trade, and is pro-ratedfraction of a percent to more than 100% of the value of the short trade, and is pro-rated

for the number of days that the short trade is open. As the hard-to-borrow rate canfor the number of days that the short trade is open. As the hard-to-borrow rate can

fluctuate substantially from day to day and even on an intra-day basis, the exact dollarfluctuate substantially from day to day and even on an intra-day basis, the exact dollar

amount of the fee may not be known in advance. The fee is usually assessed by theamount of the fee may not be known in advance. The fee is usually assessed by the

broker-dealer to the client’s account either at month-end or upon closing of the shortbroker-dealer to the client’s account either at month-end or upon closing of the short

trade, and if it is quite large, can make a big dent in the profitability of a short trade ortrade, and if it is quite large, can make a big dent in the profitability of a short trade or

exacerbate losses on it.exacerbate losses on it.

Dividends and other paymentsDividends and other payments – The short seller is responsible for making dividend – The short seller is responsible for making dividend

payments on the shorted stock to the entity from whom the stock has been borrowed.payments on the shorted stock to the entity from whom the stock has been borrowed.

The short seller is also on the hook for making payments on account of other eventsThe short seller is also on the hook for making payments on account of other events

associated with the shorted stock, such as share splits, spin-offs and bonus share issues,associated with the shorted stock, such as share splits, spin-offs and bonus share issues,

all of which are unpredictable events.all of which are unpredictable events.

Apart from these costs, risks associated with short selling include the following:Apart from these costs, risks associated with short selling include the following:

Risk of short squeezes and “buy-ins”Risk of short squeezes and “buy-ins” – A stock with very high short interest may – A stock with very high short interest may

occasionally surge in price—typically when a positive development in the stock or broadoccasionally surge in price—typically when a positive development in the stock or broad

market triggers massive short-covering—creating what is known as a “market triggers massive short-covering—creating what is known as a “short squeezeshort squeeze.”.”

Heavily shorted stocks are also vulnerable to “buy-ins,” which occurs when a broker-Heavily shorted stocks are also vulnerable to “buy-ins,” which occurs when a broker-

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6. Short Selling Analytics

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dealer closes out short positions in a difficult-to-borrow stock because its lenders aredealer closes out short positions in a difficult-to-borrow stock because its lenders are

demanding it back. The risk of a “buy-in” is a major risk with short selling because of itsdemanding it back. The risk of a “buy-in” is a major risk with short selling because of its

unpredictability and can lead to unexpected losses for the short seller.unpredictability and can lead to unexpected losses for the short seller.Regulatory risksRegulatory risks – Regulators may sometimes impose bans on short sales in a specific – Regulators may sometimes impose bans on short sales in a specific

sector or even in the broad market to avoid panic and unwarranted selling pressure.sector or even in the broad market to avoid panic and unwarranted selling pressure.

Such actions can cause a sudden spike in stock prices, forcing the short seller to coverSuch actions can cause a sudden spike in stock prices, forcing the short seller to cover

short positions at huge losses.short positions at huge losses.

Contrary to long-term market trendContrary to long-term market trend – As the long-term trend of the market is upward, – As the long-term trend of the market is upward,

short selling is a contrarian strategy. Unlike a buy-and-hold strategy, it has to beshort selling is a contrarian strategy. Unlike a buy-and-hold strategy, it has to be

opportunistic and well timed.opportunistic and well timed.

Skewed payoff ratioSkewed payoff ratio – Short selling has a skewed payoff ratio as the maximum gain – – Short selling has a skewed payoff ratio as the maximum gain –

which occurs if the shorted stock was to fall to zero – is limited, but the maximum losswhich occurs if the shorted stock was to fall to zero – is limited, but the maximum loss

is theoretically infinite.is theoretically infinite.

Short selling is a gamble.Short selling is a gamble.History has shown that, in general, stocks have an upward drift. Over the long run, mostHistory has shown that, in general, stocks have an upward drift. Over the long run, most

stocks appreciate in price. For that matter, even if a company barely improves over the years,stocks appreciate in price. For that matter, even if a company barely improves over the years,

inflationinflation should drive its stock price up somewhat. What this means is that shorting is betting should drive its stock price up somewhat. What this means is that shorting is betting

against the overall direction of the market.against the overall direction of the market.

So, if the direction is generally upward, keeping a short position open for a long period canSo, if the direction is generally upward, keeping a short position open for a long period can

become very risky. (To learn more, read become very risky. (To learn more, read Stocks Are No.1Stocks Are No.1 and and The Stock Market: A LookThe Stock Market: A Look

BackBack.).)

Losses can be infinite.Losses can be infinite.When you short sell, your losses can be infinite. A short sale loses when the stock price risesWhen you short sell, your losses can be infinite. A short sale loses when the stock price rises

and a stock is (theoretically, at least) not limited in how high it can go. and a stock is (theoretically, at least) not limited in how high it can go. For example, if youFor example, if you

short 100 shares at $65 each hoping to make a profit but the shares increase to $90 apiece,short 100 shares at $65 each hoping to make a profit but the shares increase to $90 apiece,

you end up losing $2,500.you end up losing $2,500. On the other hand, a stock can't go below 0, so your upside is On the other hand, a stock can't go below 0, so your upside is

limited. Bottom line: you can lose more than you initially invest, but the best you can earn is alimited. Bottom line: you can lose more than you initially invest, but the best you can earn is a

100% gain if a company goes out of business100% gain if a company goes out of business and the stock loses its entire value and the stock loses its entire value..

Shorting stocks involvesShorting stocks involvesusing borrowed money.using borrowed money.This is known as This is known as margin tradingmargin trading.. When short When short

selling, you open a margin account, which allowsselling, you open a margin account, which allows

you to borrow money from the brokerage firmyou to borrow money from the brokerage firm

using your investment as collateral. using your investment as collateral. Just as whenJust as when

you go long on margin, it's easy for losses to getyou go long on margin, it's easy for losses to get

out of hand because you must meet the minimumout of hand because you must meet the minimum

maintenancemaintenance requirement of 25%. If your account requirement of 25%. If your account

slips below this, you'll be subject to a slips below this, you'll be subject to a margin callmargin call,,

and you'll be forced to put in more cash or liquidate your position. and you'll be forced to put in more cash or liquidate your position. (We won't cover margin(We won't cover margin

in detail here, but you can read more in our in detail here, but you can read more in our Margin Trading tutorialMargin Trading tutorial.).)

Short squeezes can wring the profit out of yourShort squeezes can wring the profit out of yourinvestment.investment.When stock prices go up short seller losses get higher, as sellers rush to buy the stock toWhen stock prices go up short seller losses get higher, as sellers rush to buy the stock to

cover their positions. This rush creates a high demand for the stock cover their positions. This rush creates a high demand for the stock quickly driving up thequickly driving up the

price even further. This phenomenon is known as a price even further. This phenomenon is known as a short squeezeshort squeeze. Usually, news in the. Usually, news in the

market will trigger a short squeeze, but sometimes traders who notice a large number ofmarket will trigger a short squeeze, but sometimes traders who notice a large number of

shorts in a stock will attempt to induce one. This is why it's not a good idea to short a stockshorts in a stock will attempt to induce one. This is why it's not a good idea to short a stock

with high short interest. A short squeeze is a great way to lose a lot of money extremely fast.with high short interest. A short squeeze is a great way to lose a lot of money extremely fast.

(To learn more, see (To learn more, see Short Squeeze The Last Drop Of Profit From Market MovesShort Squeeze The Last Drop Of Profit From Market Moves.).)

Even if you're right, it could be at the wrong time.Even if you're right, it could be at the wrong time.

Trading CenterTrading Center

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Next: Next: Ethics And The Role Of Short SellingEthics And The Role Of Short Selling

The final and largest complication is being right too soon. Even though a company isThe final and largest complication is being right too soon. Even though a company is

overvalued, it could conceivably take a while to come back down. In the meantime, you areovervalued, it could conceivably take a while to come back down. In the meantime, you are

vulnerable to interest, margin calls and being called away. Academics and traders alike havevulnerable to interest, margin calls and being called away. Academics and traders alike have

tried for years to come up with explanations as to why a stock's market price varies from itstried for years to come up with explanations as to why a stock's market price varies from its

intrinsic valueintrinsic value. They have yet to come up with a model that works all the time, and probably. They have yet to come up with a model that works all the time, and probably

never will.never will.

Take the dotcom Take the dotcom bubblebubble, for example. Sure, you could have made a killing if you shorted at, for example. Sure, you could have made a killing if you shorted at

the market top in the beginning of 2000, but many believed that stocks were grosslythe market top in the beginning of 2000, but many believed that stocks were grossly

overvalued even a year earlier. You'd be in the poorhouse now if you had shorted the Nasdaqovervalued even a year earlier. You'd be in the poorhouse now if you had shorted the Nasdaq

in 1999! in 1999! That's when the Nasdaq was up 86%, although two-thirds of the stocks declined. That's when the Nasdaq was up 86%, although two-thirds of the stocks declined. ThisThis

is contrary to the popular belief that pre-1999 valuations more accurately reflected theis contrary to the popular belief that pre-1999 valuations more accurately reflected the

Nasdaq. However, it wasn't until three years later, in 2002, that the Nasdaq returned to 1999Nasdaq. However, it wasn't until three years later, in 2002, that the Nasdaq returned to 1999

levels.levels.

Momentum is a funny thing. Whether in physics or the stock market, it's something you don'tMomentum is a funny thing. Whether in physics or the stock market, it's something you don't

want to stand in front of. All it takes is one big shorting mistake to kill you. Just as youwant to stand in front of. All it takes is one big shorting mistake to kill you. Just as you

wouldn't jump in front of a pack of stampeding bulls, don't fight against the trend of a hotwouldn't jump in front of a pack of stampeding bulls, don't fight against the trend of a hot

stock.stock.

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6. Short Selling Analytics

7. Short Selling Alternatives

8. Risks of Short Selling

9. Ethics And The Role Of Short Selling

10. Short Selling Guide: Conclusion

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MarkdownMarkdownThe difference between the highest currentThe difference between the highest currentbid price among dealers ...bid price among dealers ...

CatalystCatalystA catalyst in equity markets is a revelation orA catalyst in equity markets is a revelation orevent that propels ...event that propels ...

InvestingInvestingThe act of committing money or capital to anThe act of committing money or capital to anendeavor with the ...endeavor with the ...

Bear ClosingBear ClosingPurchasing a security, currency, orPurchasing a security, currency, orcommodity in order to close ...commodity in order to close ...

Crowded ShortCrowded ShortA trade on the short side with anA trade on the short side with anoverwhelmingly large number ...overwhelmingly large number ...

Gross ExposureGross ExposureThe absolute level of a fund's investments.The absolute level of a fund's investments.

A:A:

A:A:

A:A:

A:A:

A:A:

A:A:

Q: Q: Is short selling a form of insurance?Is short selling a form of insurance?Short selling really isn't a form of insurance. It is the opposite of going long or buying a stock with theShort selling really isn't a form of insurance. It is the opposite of going long or buying a stock with the

hope that the ... hope that the ... Read Full Answer >>Read Full Answer >>

Q: Q: What kinds of restrictions does the SEC put on short selling?What kinds of restrictions does the SEC put on short selling?Since the stock market crash in 1929, and the ensuing Great Depression, short selling has been theSince the stock market crash in 1929, and the ensuing Great Depression, short selling has been the

scapegoat in many market ... scapegoat in many market ... Read Full Answer >>Read Full Answer >>

Q: Q: What is a stock split? Why do stocks split?What is a stock split? Why do stocks split?All publicly-traded companies have a set number of shares that are outstanding on the stock market. AAll publicly-traded companies have a set number of shares that are outstanding on the stock market. A

stock split is a decision ... stock split is a decision ... Read Full Answer >>Read Full Answer >>

Q: Q: How do I place an order to buy or sell shares?How do I place an order to buy or sell shares?It is easy to get started buying and selling stocks, especially with the advancements in online tradingIt is easy to get started buying and selling stocks, especially with the advancements in online trading

since the turn of ... since the turn of ... Read Full Answer >>Read Full Answer >>

Q: Q: Is there a difference between financial spread betting and arbitrage? (AAPL, NFLX)Is there a difference between financial spread betting and arbitrage? (AAPL, NFLX)Financial spread betting is a type of speculation that involves a highly leveraged derivative product,Financial spread betting is a type of speculation that involves a highly leveraged derivative product,

whereas arbitrage ... whereas arbitrage ... Read Full Answer >>Read Full Answer >>

Q: Q: What does a high turnover ratio signify for an investment fund? (KNOW)What does a high turnover ratio signify for an investment fund? (KNOW)If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over aIf an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a

one-year period. ... one-year period. ... Read Full Answer >>Read Full Answer >>

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