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Salutator comments on Stupid Questions, December 2015 - Less Wrong
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Repeating my question from late in the previous thread:
It seems to me that if you buy a stock, you could come out arbitrarily well-off, but your losses are limited to the amount you put in. But if you short, your payoffs are limited to the current price, and your losses could be arbitrarily big, until you run out of money.
Is this accurate? If so, it feels like an important asymmetry that I haven't absorbed from the "stock markets 101" type things that I've occasionally read. What effects does it have on markets, if any? (Running my mouth off, I'd speculate that it makes people less inclined to bet on a bubble popping, which in turn would prolong bubbles.) Are there symmetrical ways to bet a stock will rise/fall?
It gets very interesting if there actually are no stocks to buy back in the market. For details on how it gets interesting google "short squeeze".
Other than that exceptional situation it's not that asymmetrical:
-Typically you have to post some collateral for shorting and there will be a well-understood maximum loss before your broker buys back the stock and seizes your collateral to cover that loss. So short (haha) of a short squeeze there actually is a maximum loss in short selling.
-You can take similar risks on the long side by buying stocks on credit ("on margin" in financial slang) with collateral, which the bank will use to close your position if the stock drops too far. So basically long risks also can be made as big as your borrowing ability.