Yep, losses can be absolutely Huge! Here's a piece from the note we got in July, 2011 from SLI concerning the shorting:
Legal and Illegal Shorting
Legal and illegal shorting are both done in “margin accounts”. With a margin account the broker lends you a portion of the funds at the time of purchase and the shares act as collateral as compared to a “cash account” that requires that you pay for your stock when you make the purchase.
Legal Shorting: To carry out a legal short sale, a short seller first must ensure that he has enough cash or equity in his margin account as collateral for the initial short margin requirement. Margin requirements differ for each brokerage firm or financial institution (i.e. BMO margin requirements for a stock trading at $2.00 or more is 150% of its trading price therefore to short 10,000 shares at $2.50, a short seller must provide cash or have equity of at least $37,500.)
The short seller sells the shares and the proceeds are credited to his margin account. Upon completion of the sale, the short seller has three days to cover (buy back the shares he sold which he didn’t own) or meet appropriate margin requirements. If the share price increases, the short seller will receive a margin call from the broker, demanding that the short seller either cover his short position (by purchasing the shares) or provide more cash in order to meet the additional margin requirement for the shares. For example, if the shares increased from $2.50 to $3.00, the short seller would have to put up additional cash –margin requirements of $37,500 would now increase to $45,000.
The transaction concludes when the short seller buys back the shares he sold short. If the price has dropped, he makes a profit. If the price has increased, he takes a loss.
Legal shorting, while being costly and risky, effectively puts a limit on the amount of money that can be lost because of the strict rules regarding margin requirements.
Legal shorting must be declared and reported to regulatory authorities.
Illegal Shorting: Illegal short selling occurs when shares are sold short without declaring the short sale and without providing the proper margin requirements (as with legal shorting.) Brokers lend/rent out the shares to a short seller for an indefinite amount of time for a fee (i.e 15%, 20%, 30% or higher.) Shares held by brokerage firms or other financial institutions in other clients’ margin accounts can be borrowed for this purpose. Brokers receive a fee which may or may not be shared with the client who holds the shares in his margin account. Most shareholders are not aware that their shares are being lent out.
While illegal shorting avoids the extensive cash requirements of legal shorting, it is very, very risky. Losses can be infinite. A short sale loses when the share price rises and a stock is (theoretically, at least) not limited in how high it can go.
Short sellers also risk getting caught in what is known as a “short squeeze” where stock prices go up causing short seller losses to get higher and the short sellers rush to buy the shares to cover their positions. This rush creates a high demand for the stock, quickly driving up the price even further. A short squeeze is a great way for shorters to lose a lot of money extremely fast. One big shorting mistake can kill. Just as you wouldn’t jump in front of a pack of stampeding bulls, don’t fight against the trend of a hot stock.
