What are the risks of short selling?

(1) Asymmetry between Risk and Return

The asymmetry between risk and return is an inherent risk of short selling. Theoretically, when investors go long on a stock, the maximum loss is when the stock price drops to 0, i.e., a loss of 100%; however, when investors short a stock, relative to the short selling price, there is no limit to the subsequent upward movement of the stock price, so the potential loss is unlimited and could be 200%, 300%, or even higher.

(2) Time Cost

Time factors must be considered when short selling. On one hand, interest is generated every day during short selling operations, and costs increase over time; on the other hand, the greatest uncertainty of short selling also comes from time. If investors hold short positions for a long time, they may face risks brought by rising stock prices.

(3) Interest Rate Risk

It should be noted that after placing a short selling order, the short selling interest rate is still variable. The interest ultimately paid by investors is calculated according to the actual interest rate of each day starting from that day, and is calculated at 23:00 market time (US stocks at 23:00 US time, Hong Kong stocks at 23:00 Hong Kong time). Margin trading interest will be deducted from your stock account cash balance. No one can determine the short selling rate in advance. If the degree of short selling congestion on individual stocks increases significantly during the holding period, leading to a sharp increase in interest rates, investors need to bear the increased short selling costs, which may result in short selling interest exceeding short selling profits and cause losses.

(4) Recall and Forced Liquidation

During short selling operations, the relationship between short investors and lenders is asymmetric. Stock lenders/borrowers reserve the right to demand the return of the stock at any time. If a recall occurs, the broker will attempt to replace the previously borrowed stock with stock borrowed from another lender. If the stock cannot be borrowed, a formal recall will be initiated. Recalls are usually executed using Volume Weighted Average Price (VWAP) orders to close out the client's short position. In addition, if the stock price continues to rise after borrowing the stock, the margin requirement for that stock will continue to increase. Once margin is insufficient, forced liquidation will be triggered. If a stock with a high short ratio surges, it may cause many short investors to rush to close their positions at the same time, leading to further stock price increases.

(5) Corporate Actions

Certain corporate actions (such as mergers, acquisitions, dividends, etc.) may cause an increase in short selling rates. For example, when a company announces a dividend, it usually leads to a decrease in the supply of shares in the market, which may result in an increase in the short selling interest rate.

(6) Delisting and Suspension

When a stock is delisted or suspended, since the stock cannot be traded, investors may not be able to cover their short positions and must wait until the stock completes delisting or resumes trading before they can terminate. This process may last for days, months, or even longer, especially when the company goes through bankruptcy liquidation. During this period, investors must continue to pay short selling fees based on the delisting price of the stock or the closing price on the last trading day, and the short selling fees may be very high.