When you &quot;short sell&quot; a stock, you&#x27;re betting that the price is going down. Now, for you to actually profit from the downswing the transaction has to be structured in a certain way.<p>The way this works is that you place an order with your broker to &quot;short&quot; a certain amount of stock. Let&#x27;s say a lot of 100 shares. What they do is immediately purchase and then sell 100 shares. Let&#x27;s say the price at this point is $100 a pop. Your account is thus credited $100 x 100 = $10,000.<p>Now, a short sale entitles the broker to the equivalent number of shares to close the position (this is called &quot;covering&quot;). So, since in this case they purchased and sold 100 shares, you now owe them 100 shares.<p>Let&#x27;s say the price drops to $50 and you want to close. You simply buy 100 shares @ $50 and pay 100 x $50 = $5000. Remember how your account had been credited $10000? You&#x27;re now left with $5000 which is your profit to keep.<p>But... what if the price had gone up to $200? $400?
In that case, you still owe them 100 shares. So you&#x27;d have to pay 100 x $200 = $20000 (leaving you with a net loss of $10k) or 100 x $400 = $40000 (leaving you with a net loss of $30k) respectively. As you can see, your downside is theoretically unlimited.<p>This downside is particularly relevant with very small stocks. With a stock valued around $2&#x2F;share, it&#x27;s much easier for it to 10x in value than a $50-100&#x2F;share stock.<p>For this reason, you need to have one of the following tools available to you when shorting:
1) A great broker that will monitor and close out of huge losses
2) An opposing limit order (an order that triggers when a stock reaches a certain price, allowing you to cover)
3) A computerized trading system that will react to an adverse situation instantaneously.