How to lose $5B in one week: When it comes to short selling, here are three pieces of advice “Don’t short, don’t short, do not short”! Unless you really know what you are doing. And even then, don’t do it! The saga of the past week in the case of the stock of GameStop illustrated the dire consequences of short-selling gone wrong. The perfect storm ensued when Reddit-ors discovered that a hedge fund had taken a large short position in GameStop and collectively started buying up the stock causing its price to go up. In a short sale, you are essentially selling the stock at the current price (by borrowing the stock from the broker) in the expectation of the stock price going down in the future in which case you buy back at the lower price and make a profit on the difference between the higher selling price and lower buying price. All this sounds fine until you consider what happens if the stock price were to go up. Since there is no barrier as to how high the price can go, the losses for the short seller can be potentially infinite. What can result is a “short squeeze” where the purchase of the stock to cover the short by a major player, causes the stock price to go even higher. Adding to the loss potential is the fact that there are costs for borrowing the stock from the broker – which can be up to 100% of the value of the trade. Plus, there are payments that the short seller is on the hook for such as paying dividends to the lender of the stock. For GameStop, GME, the perfect storm led to the hedge fund Melvin Capital losing about 30% of its 12 Billion of assets in one week!
