If an individual shorts stock at an investment bank, there is a limit to the amount of money the individual can lose.
The investment bank has some type of collateral, usually the rest of your portfolio. When your net worth hits a certain threshold, perhaps $0 net worth of your portfolio, the bet is over. You lost all your money, and you don't end up in debt. In practice, the investment bank will cut you off before you reach this point.
But if you are an investment bank, there is no one controlling you on a daily basis, so you can dip into the negative in theory.
The problems with doing this are:
- Regulators. Once the regulator finds out you're negative, they will shut down your investment bank. Hopefully, they do this before you hit 0, but they may not get it exactly right.
- Counterparties. Other investment banks will refuse to do business with you when they know you are negative, or close to it. Once this happens, it's game over.
So in both cases, individual or investment bank, there is a practical limit on how much you can lose from one short bet. That limit is equal to your net worth.
You could lose any amount of money up to that on one short. It's risky.
There are also ways to limit your losses. You can purchase other contracts to limit your losses. This is kind of like insurance. In general, you are not required to buy this. Some people and institutions do not do this because of the expense. Most institutions structure each deal so there is no way one deal will risk the entire business. Smart people also take steps to make sure one trade does not wipe them out.
This runs completely counter to my understanding of shorting and I just checked on my brokerage - there is no limit. The unbounded losses bit is the whole point of put options instead of shorts.
> Many short sellers place a stop order with their stockbroker after selling a stock short—an order to the brokerage to cover the position if the price of the stock should rise to a certain level. This is to limit the loss and avoid the problem of unlimited liability described above. In some cases, if the stock's price skyrockets, the stockbroker may decide to cover the short seller's position immediately and without his consent to guarantee that the short seller can make good on his debt of shares.
Otherwise you'd make yourself liable for a literally unlimited sum of money. Any short could completely bankrupt your entire personal finances or your entire institution in that case.
Normally you set a limit when you short. You don’t agree to pay an unlimited amount of money.