Most investors build wealth by buying low and selling high, stacking returns slowly over years of patient and disciplined market participation. But a growing number of traders are drawn to a strategy that flips that logic entirely, betting that a stock’s price will fall.
However, SoFi’s latest educational breakdown walks through how this high-risk strategy operates, what it costs you, and why it has destroyed professional funds. Before investors consider placing this type of trade, they need to understand the mechanics that make it dangerous.
How short selling works and why traders are drawn to it
Short selling means borrowing shares from your brokerage, selling them at today’s market price, and then repurchasing them later at a lower price. You return the borrowed shares to your broker and keep the difference as profit.
“Short-selling plays the role of real-time financial watchdog. It’s one of the few checks and balances in the market.” said Jim Chanos, Founder, Kynikos Associates.
If you borrow and sell 100 shares at $50 each, then buy them back at $40, you pocket $1,000 minus any applicable trading and borrowing fees, according to SoFi. Traders typically short stocks when they believe a company is overvalued, has weakening fundamentals, or faces declining earnings.
Some institutional investors also use short positions as a hedge against their existing long holdings. Short selling is legal and recognized as a legitimate trading strategy that contributes to efficient price discovery across public equity markets, according to the Securities and Exchange Commission.
The margin requirements that most short sellers underestimate
Your brokerage will not let you short a stock from a standard cash account because this trade requires you to borrow shares through a margin account. The initial margin requirement for a short sale is 150% of the security’s current market value, according to Federal Reserve Regulation T and FINRA Rule 4210.
That means shorting $10,000 worth of stock requires you to deposit $15,000 upfront before you can even open your position and start trading. FINRA also requires you to maintain at least 30% of the stock’s current market value in your account at all times.
If the stock price rises and your account equity drops below that threshold, your broker will issue a margin call requiring you to deposit additional cash immediately. Margin interest charges also compound on the borrowed shares over time.
Brokerage firms can charge interest rates ranging from a few basis points to well over 100%, depending on how difficult it is to borrow the shares from other investors, according to SoFi.
Your losses have no ceiling when you short a stock
When you buy a stock the traditional way, the most you can lose is your initial investment if the share price drops to zero. Short selling inverts that equation because a stock’s price can theoretically rise without any limit at all.
If you short 100 shares at $50 and the stock climbs to $200, you now owe $20,000 on what started as a $5,000 position. Margin requirements compound those losses because your broker can force you to deposit additional cash or liquidate your position at any time.
Stop-loss orders can help manage risk by automatically closing your position when the stock moves against your thesis by a set amount. But in fast-moving or volatile markets, stop-loss orders may execute at prices far worse than your specified level, according to SoFi.
GameStop proved short selling can destroy even the most well-funded hedge funds
Melvin Capital built a massive short position against GameStop in late 2020, betting the struggling video game retailer’s stock would keep declining. Retail investors on Reddit’s r/WallStreetBets forum identified the vulnerability and began buying shares in a coordinated fashion throughout January 2021.
The resulting short squeeze sent GameStop’s stock from under $20 to nearly $500 per share within weeks. Melvin Capital lost 53% of its assets under management, totaling roughly $6.8 billion in losses, during January 2021 alone.
Citadel and Point72 had to provide a combined $2.75 billion emergency cash infusion just to keep the fund operating through the crisis. Melvin Capital never recovered and permanently shut down all operations in May 2022, erasing years of consistent 30% annual returns.
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Short sellers collectively lost more than $6 billion on GameStop alone during the 2021 squeeze, according to analytics firm S3 Partners. Citron Research founder Andrew Left announced his firm would stop publishing short-selling research entirely after suffering total losses on its position.
D1 Capital Partners lost $4 billion, proving that even diversified institutional portfolios face devastating squeeze exposure. The GameStop episode was not an isolated incident, as similar squeezes hit AMC Entertainment and other heavily shorted stocks during the same period.
Defined-risk alternatives if you want to bet against a stock
If you want to profit from a declining stock price without the unlimited loss exposure of short selling, put options offer a defined-risk alternative.
A put option gives you the right to sell shares at a specified strike price before the contract’s expiration date, for a fixed premium. Your maximum loss is limited to the premium you paid for the contract, which makes the overall risk profile far more manageable for individual investors, according to SoFi.
Inverse ETFs provide another approach for bearish investors, as these funds use derivatives to deliver returns that move inversely to a specific market index. If the S&P 500 drops 1% on a given trading day, a corresponding inverse ETF is designed to rise approximately 1% during that session.
New SEC rules are bringing unprecedented transparency to short selling
The SEC adopted Rule 13f-2 in October 2023, requiring institutional investment managers with short positions exceeding $10 million or 2.5% of outstanding shares to file monthly reports, according to an SEC press release.
This transparency measure was a direct response to the GameStop saga and broader concerns about manipulative activity in public equity short selling.
The initial compliance deadline was extended to February 2028 to give firms more time to build reporting infrastructure. “Abusive naked short selling as part of a manipulative scheme remains unlawful, and the Commission will use its regulatory tools to combat such illegal activity,” SEC Acting Chairman Mark Uyeda stated in February 2025.
Short selling is not a strategy for your retirement portfolio
Short selling generally sits within a narrower, more specialized segment of the market. FINRA’s investor education materials describe it as a strategy typically used by traders looking to profit from short-term price fluctuations rather than long-term portfolio building.
The structure introduces distinct risks that regulators warn about explicitly. FINRA notes that if the price of a shorted stock rises, the short seller loses money and because there is no ceiling on how high a stock price can go, potential losses are theoretically unlimited.
Investors also face ongoing borrowing costs, and sharp price reversals such as short squeezes add another layer of risk. FINRA Rule 4210 requires strict margin requirements, and brokers can liquidate positions without notice if account equity falls below maintenance thresholds.
For these reasons, short selling is more often viewed separately from approaches used for retirement savings, education funds, or broad wealth accumulation.
