What are the risks associated with short selling?

What are the risks associated with short selling?

Short selling comes with significant inherent risks that you must understand:

  1. Market risk and unlimited losses: There is no limit to how high a stock price can rise. Potential losses from short positions also rise without limit, unlike buying stocks where the maximum loss is your investment. In a worst case, prices skyrocket causing massive losses when you buy back shares at much higher prices.

  2. Margin calls: Short selling uses margin, meaning you borrow money from our clearing firm to fund the trade. If the stock price rises and losses increase, Redbridge may issue a margin call requiring additional funds to maintain your position. Failure to meet calls promptly results in forced liquidation of your short position.

  3. Interest and fees: You must pay interest and fees to borrow shares for short selling. These costs accumulate over time and reduce profits, especially if the price does not drop as expected or rises. The longer you hold the short, the greater the costs to maintain it.

  4. Dividend risk: Short sellers are responsible for paying any dividends to the lender. This further increases costs and lowers potential profits on the short position. The dividend amounts are unpredictable and beyond your control.

  5. Short squeezes: If a heavily shorted stock price starts rising, short sellers rush to buy back shares to close positions and cap losses. This buying fuels further price hikes, forcing more short sellers to cover. The feedback loop causes sharp price spikes and substantial losses for those caught in the squeeze who have to buy back shares at much higher prices.

  6. Liquidity risk: Borrowing shares for short selling may be difficult or costly if availability is limited. The lender may increase fees or it could be impossible to short the stock. Your position depends entirely on the ability and willingness of others to lend shares.