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The dangers of shorting
- Thread starter gordon277
- Start date
GordonTheGekko
Guest
Gordon, yes there is the possibility a lack of volume would leave a short position out to dry. Avoiding shorting light volume stocks, and avoiding shorting ETFs altogether (because almost no traders short ETFs since there are usually inverse ETFs that do the job) will guard against this. Better yet, buy puts.
Use any broker besides IB & you don't have that problem. By Ib liquidations are done by a computer with 1 minute (not 10 minutes you mentioned), other broker it is done by a human being & usually takes hours or a day. Also when a "person" looks on your postion, they will realize if there is a mistaken quote..Quote from gordon277:
Here's a hypothetical situation. You short some >$20 stock for a few days, for a total of say 3% of your capital - a pretty safe trade overall. But then due to either
1) an error on the exchange, the broker, or anywhere in between
2) lack of liquidity
3) trader error
the stock jumps some ridiculous amount and stays there for some time.
For example, some large trader's software went haywire and placed a ridiculously large bid and ate up all the asks, then an automated spread ask comes in, and all of a sudden the stock is valued at 100x what it was the day before. And if this situation persists for longer than whatever the auto liquidation period is (10 mins for IB), your entire account gets liquidated and that short position gets liquidated at the new 100x price. And now you blew your entire account and you might owe money to the broker.
Granted, this situation is very extreme and highly unlikely, but it's not impossible. Just like healthy stocks dropping to $.01 during the Flash crash was highly unlikely. And during a lifetime of trading, with tens of thousands of trades, it would take only one such anomaly to bankrupt you.
There's another, much older thread that also talks about a hypothetical situation that could potentially blow your entire account due to margin:
http://www.elitetrader.com/vb/showthread.php?threadid=198220
This type of scenario can only happen with short/margin positions. With long only positions, you just have to wait out the madness.
What do you guys think, is that a reasonable concern? Do you protect yourself from something like that? Do you use margin/shorting at all?
Quote from GordonTheGekko:
Gordon, yes there is the possibility a lack of volume would leave a short position out to dry. Avoiding shorting light volume stocks, and avoiding shorting ETFs altogether (because almost no traders short ETFs since there are usually inverse ETFs that do the job) will guard against this. Better yet, buy puts.
+1 This...
Never trade long OR short an instrument that cannot be liquidated in 30 sec or less. Also, if you set STOP LIMIT orders where the stop is the trigger and the limit is some OTHER price close to but within an "acceptable" range of sale prices from the stop price, then this will at least give you some breathing room if prices gap past a stop price. Also this ensures that your STOP is not triggered at market price as you have a limit in place. A STOP is simply a trigger that sells at market price. STOP LIMIT has an added extra margin of safety.
However, as we all know nothing in this world is 100% and at any time you must be prepared for the worst and do what you can to prevent it.
Quote from gordon277:
I'm no expert on options, but I don't think that's a valid alternative. Puts trade on a much lower volume than the underlying stock. If the stock is not very liquid to begin with, there might not be any puts. And even if there are puts, the bid/ask spreads are much higher. There are also added variables that you have to deal with, like the added cost for it being an option and the added cost for volatility.
there are about 3200 optionable stocks excl. etfs
there are about 1750 optionable stocks that have adv above 500k
so either stick to those stocks with high adv for lower b/a spreads and/or be prepared to spend more time working orders w/ less liquid options.
re variables like cost/iv, you are right, although diff strategies can mitigate this somewhat if you're willing to give up some gains (put backspread/spread/etc instead of just buying a put).
NEVER use market orders, period the end. even on the most liquid option like spy. just enter a limit buy at the offer or 1 cent above if you feel you must get in now - remember a limit order doesn't mean that's the price you pay - only the max price. i've checked trade executions and seen the price 1 or 2 cents below my limit when buying even a liquid option and been pleasantly surprised.
bottom line i prefer being long options b/c i know the ABSOLUTE worst thing that can happen. i remember the VOW short squeeze - it didn't make sense but the losses were very real. if you bought puts you lose the premium. if you shorted your port was fubar.