What are the risks of short selling Stocks?

Short selling allows you to sell a security without having to own it (because virtually everything except stocks can send you to jail) If a price of a stock drops below its short-sale price you profit. But if the stock price raises you may lose.

The potential loss does not have limits because if stocks continue raising loss increases. Let’s suppose you thought that certain internet stocks were overvalued during its irrational exuberance period and decides to sell some in short. During the crazy price inflation very large loss would have been caused.

AOL stocks (now part of Time Warner) raised from $100 to $400 each in a pre split short term basis. If you had sold short at $100 per stock and would not have covered your position (buying your stocks back) you would have had to face the possibility of buying these same stocks at very high prices resulting in a great loss per stock.

With a long position  the most you can lose is the amount you invested (you bought a $12 stock and it dropped to $0). Instead a short selling has no limits while higher the price greater the loss.

You have to be aware of risks. Stocks may be sold short only if prices of these in precedent negotiations have been negotiated in an up-tick or a zero tick. An up-tick means that existing negotiation prices must exceed preceding negotiating prices. A zero tick means that the most recent negotiation prices are the same than in preceding negotiations. That way if the price of a stock drops hastily its short sale could not be carried out.

The short seller is also required to pay dividends the company declares the owner of lent securities. Besides incomes coming from a short sale are used as collaterals by securities borrowed from the brokerage firm. The short is also required to provide additional funds (the margin requirement of 50% set by the Federal Reserve). If the stock continues in a flat trading range funds and the short seller margin requirement stays in the account.