Editing Short (finance) (section)

== Risks ==
{{More citations needed|date=April 2009}}
'''Note: this section does not apply to currency markets.'''

Short selling is sometimes referred to as a "negative income investment strategy" because there is no potential for dividend income or interest income. Stock is held only long enough to be sold pursuant to the contract, and one's return is therefore limited to short term [[capital gain]]s, which are taxed as ordinary income. For this reason, buying shares (called "going long") has a very different [[risk]] profile from selling short.  Furthermore, a "long's" losses are limited because the price can only go down to zero, but [[Gain (accounting)|gain]]s are not, as there is no limit, in theory, on how high the price can go.  On the other hand, the short seller's possible gains are limited to the original price of the stock, which can only go down to zero, whereas the loss potential, again in theory, has no limit.  For this reason, short selling probably is most often used as a [[hedge (finance)|hedge]] strategy to manage the risks of long investments.

Many short sellers place a ''[[stop order]]'' with their stockbroker after selling a stock short—an order to the brokerage to cover the position if the price of the stock should rise to a certain level. This is to limit the loss and avoid the problem of unlimited liability described above.  In some cases, if the stock's price skyrockets, the stockbroker may decide to cover the short seller's position immediately and without his consent to guarantee that the short seller can make good on his debt of shares.

Short sellers must be aware of the potential for a [[short squeeze]].  When the price of a stock rises significantly, some people who are shorting the stock cover their positions to limit their losses (this may occur in an automated way if the short sellers had stop-loss orders in place with their brokers); others may be forced to close their position to meet a [[Margin calls|margin call]]; others may be forced to cover, subject to the terms under which they borrowed the stock, if the person who lent the stock wishes to sell and take a profit. Since covering their positions involves buying shares, the short squeeze causes an ever further rise in the stock's price, which in turn may trigger additional covering.  Because of this, most short sellers restrict their activities to heavily traded stocks, and they keep an eye on the "short interest" levels of their short investments. Short interest is defined as the total number of shares that have been ''legally'' sold short, but not covered. A short squeeze can be deliberately induced. This can happen when large investors (such as companies or wealthy individuals) notice significant short positions, and buy many shares, with the intent of selling the position at a profit to the short sellers, who may be panicked by the initial uptick or who are forced to cover their short positions to avoid margin calls.

Another risk is that a given stock may become "hard to borrow". As defined by the SEC and based on lack of availability, a broker may charge a hard to borrow fee daily, without notice, for any day that the SEC declares a share is hard to borrow. Additionally, a broker may be required to cover a short seller's position at any time ("buy in"). The short seller receives a warning from the broker that he is "failing to deliver" stock, which leads to the buy-in.<ref>{{cite web |last=Arnold |first=Roger |url=http://www.thestreet.com/story/862233/1/knowing-the-rules-of-the-shorting-game.html |title=Knowing the Rules of the Shorting Game |publisher=TheStreet |date=14 January 2000 |access-date=24 May 2012 |archive-date=3 February 2023 |archive-url=https://web.archive.org/web/20230203054739/https://www.thestreet.com/personal-finance/knowing-the-rules-of-the-shorting-game-862233 |url-status=live }}</ref>

Because short sellers must eventually deliver the shorted securities to their broker, and need money to buy them, there is a credit risk for the broker. The penalties for failure to deliver on a short selling contract inspired financier [[Daniel Drew]] to warn: "He who sells what isn't his'n, Must buy it back or go to pris'n."<ref>{{cite news |title=Betting against shorts isn't wise |first=John |last=Waggoner |url=https://www.usatoday.com/money/perfi/columnist/waggon/2005-11-24-short_x.htm |work=USA Today |date=2005-11-25 |archive-url=https://web.archive.org/web/20090206165755/https://www.usatoday.com/money/perfi/columnist/waggon/2005-11-24-short_x.htm |archive-date=2009-02-06 |url-status=dead}}</ref> To manage its own risk, the broker requires the short seller to keep a [[margin (finance)|margin]] account, and charges interest of between 2% and 8% depending on the amounts involved.<ref>{{cite news| url=http://www.scottrade.com/online-brokerage/interest-margin-rates.html | work=ScotTrade | title=margin account rates schedule | date=18 June 2011}}</ref>

In 2011, the eruption of the massive [[Securities fraud|China stock frauds]] on North American equity markets brought a related risk to light for the short seller. The efforts of research-oriented short sellers to expose these frauds eventually prompted NASDAQ, NYSE and other exchanges to impose sudden, lengthy [[trading halt]]s that froze the values of shorted stocks at artificially high values. Reportedly in some instances, brokers charged short sellers excessively large amounts of interest based on these high values as the shorts were forced to continue their borrowings at least until the halts were lifted.<ref>{{cite news| url=http://online.barrons.com/article/SB50001424053111904113704576383892664177456.html?ru=yahoo&mod=yahoobarrons | work=Barrons | title=Even Short-Sellers Burned by Chinese Shares | date=18 June 2011}}</ref>

Short sellers tend to temper overvaluation by selling into exuberance.  Likewise, short sellers are said to provide price support by buying when negative sentiment is exacerbated after a significant price decline.  Short selling can have negative implications if it causes a premature or unjustified share price collapse when the fear of cancellation due to bankruptcy becomes contagious.<ref>{{cite book |url=https://books.google.com/books?id=pwXWZzxXxfwC&pg=PP7 |title=The Theory and Practice of Short Selling, Chapter 9, Conclusions and Implications for Investors by Frank J. Fabozzi, editor |date=17 November 2004 |access-date=24 May 2012 |isbn=9780471704331 |last1=Fabozzi |first1=Frank J. |publisher=John Wiley & Sons |archive-date=3 February 2023 |archive-url=https://web.archive.org/web/20230203054748/https://books.google.com/books?id=pwXWZzxXxfwC&pg=PP7 |url-status=live }}</ref>