Risks of Short Selling
Short selling carries unlimited risk. Unlike buying stocks (where you can only lose what you invest), shorting can lead to infinite losses.
Unlimited Loss Potential
When you buy a stock, the worst case is it goes to $0 and you lose your investment. When you short, there's no cap on how high the price can go. If you short at $50 and it rises to $500, you lose $450 per share.
The Short Squeeze
A short squeeze happens when a heavily shorted stock suddenly rises, forcing short sellers to buy back shares to limit losses. This buying pressure drives the price even higher, creating a feedback loop. GameStop in 2021 is a famous example.
- 1.Many traders short Stock XYZ
- 2.Good news sends price up 20%
- 3.Short sellers panic and buy to cover
- 4.Buying pressure drives price up another 30%
- 5.More shorts forced to cover, price soars
Margin Calls
Brokers require you to maintain a margin account when shorting. If the stock rises significantly, you may face a margin call—you must deposit more cash or close the position at a loss.
- Shorting has unlimited loss potential—stocks can rise indefinitely
- Short squeezes happen when rapid price increases force mass buying
- Margin requirements add complexity and risk to short positions
Answer these questions to complete the checkpoint and unlock the next one.