[Metricon]

Keep in mind that unlike purchasing a stock where the most amount of money you can lose is the amount of money you spend buying the stock (assuming you didn't buy it on margin), if you directly short a stock, there's technically no limit to the amount of money you could lose. If a stock goes up 1000% after you short it, then you could lose far more money than you put into it.

[dyauspitr]

You can always hedge your shorts and limit your downside. It’s not a huge issue unless you have absolutely no idea what you are doing.

[vl]

Does market closing and not trading continuously affects this?

If market opens at significantly different price, you may be forced to liquidate and loose more than expected.

[quickthrowman]

Not if you use options. Let’s say you short a stock that is priced at $100 and you want to limit your upside risk. You can buy a call option that gives you the right but not the obligation to purchase a stock at a specific price.

One call option in the US equity market gives you the option to purchase 100 shares of the underlying stock at the strike price.

Let’s say you want to limit the downside (upside since we’re short) risk of your short position and you’ve sold 100 shares short at $100.

You can buy a call option with with a strike price of $110 that gives you the option to buy 100 shares of stock at $110 a share, which limits your upside risk to $1000 plus the cost of the option, which let’s say in this case it expires in 90 days and costs $300 or $3/share.

If 90 days pass and the stock a trading at $120/share, you will have an open short position showing a loss of $2000, but you can ‘exercise’ the call option to purchase 100 shares at $110/share which you return to the person you borrowed them from and closes out your short position with a $1000 loss, for a total loss of -$1300, including the $300 the option costs.

If it is trading at $80 a share after 90 days, you buy back the shares at $80 each and return them, closing out your short position with a $2000 gain, for a total gain of $1700 after subtracting the $300 cost of the option, which expires with a vale of $0 since the share price is under the strike price of the option.

You can hedge a long position with put options, it’s just the inverse of what I described. If you buy 100 shares of stock at $100/share while simultaneously buying a $100 strike put option, your downside risk is limited to the cost of the put option. If the put costs $500 (or $5/share) that is all you can ever lose as long as you exercise the put option to sell the stock for $100/share if the stock price is below $100 when the option expires.

[dyauspitr]

Hopefully you have a limit order in place. You can also do more complicated hedges with options which might cost a little bit more depending on the spread but you can guarantee your hedges.

[anonymars]

It seems like a prudent warning in a thread explaining the very basics of short selling

Also worth mentioning you might be on the hook to buy it back at any time; after all, the person you borrowed it from may themselves wish to sell it. If widespread, this is the basis of "short squeezes" (e.g. of GameStop fame/infamy), if a lot of short sellers are trying to buy it back at the same time

[inigyou]

Spoken like someone who's never actually done it. Hedging to limit max loss is extremely expensive.

[dyauspitr]

I have done it before. How is it expensive, most brokers offer commission free trades now. It’s just another long order.

[inigyou]

You have to pay money to buy those options

[dyauspitr]

You can just have a limit order for the stock.

[inigyou]

That isn't hedging, that's a stop loss.

Which is the type of order you meant, not a limit order.