Have you ever gone to bed and lost hundreds of thousands of dollars? That’s the risk you run by shorting financial assets without guaranteed balance protection.

Retail trader Joe Campbell recently launched a GoFundMe campaign to raise money to help cover the $106,000 he owes to E*Trade, a popular online trading broker that doesn’t cover negative client balances. Apparently, Joe went to bed shorting KaloBios, a struggling biopharmaceutical company that recently announced it was being acquired by a famous biotech investor Martin Shkreli. Joe didn’t get the memo, and the company surged from $2 a share to as high as $19 in after-hours trading. Joe’s net account value of around $37,000 quickly turned into a hole of more than $106,000.

KaloBios surged another 31% about a week after Joe turned to GoFundMe.[1]

GoFundMe: The power of crowdsourcing

GoFundMe is an innovative crowdfunding platform that allows people to raise money for various events and causes. The platform allows users to create their own webpage to describe their fundraising cause. By advertising through integrated social media channels, users can quickly spread the word and begin receiving donations for their cause. According to the company website, GoFundMe projects have collectively raised more than $1 billion.[2]

The campaign certainly worked for Joe. He managed to raise over $5,000 in no time, prompting him to end the fundraiser.

“I’m taking the GoFundMe posting off, over $5,000 is unbelievable and will go a long way towards this debt,” Joe wrote on the website. “It is far more than I ever thought I would get by doing this page.”

Risks of short-selling

Short-selling – the sale of a security not owned by the seller [3] – is risky business because your losses are theoretically unlimited. In essence, the higher the asset price goes, the more you stand to lose. This is in stark contrast to “going long,” where traders buy a security in hopes of selling it at a higher price. The maximum loss for a long position is 100% or your entire investment.[4] Losing all of your initial investment can be devastating, but at least you won’t go into debt.

Short-selling is especially dangerous if the broker you trade with doesn’t offer negative balance projection – an explicit or implied agreement between a broker and trader that the trader can never lose more than their initial deposit. If you’re new to financial trading, work only with brokers that offer negative balance protection.

How to avoid becoming the next Joe

In addition to negative balance protection, making use of tools like guaranteed stop loss and options can help you avoid falling deep into debt.

Stop-Loss

A guaranteed stop-loss allows traders to place an absolute limit on their loss well in advance. If you’re going long on a financial asset, such as a stock or currency pair, a stop-loss places an automatic sell order [5] once the security reaches a certain price, ensuring it doesn’t fall below that price. When a stop-loss is “guaranteed,” you don’t have to worry about slippage, which is the difference between your desired price and the one you actually get.

A stop-loss order can also be used when shorting a security; in that case, the security would be purchased once it moves above a predefined price level.

Vanilla Options

Another way traders may avoid becoming like Joe is through hedging with calls and puts. This sort of hedging applies specifically to options, which allow traders to profit from rising as well as falling market trends. In options trading, a call is an agreement that gives traders the right to buy a security at a specific price within a certain time period.[6] A put is a contract giving the owner the right to sell a certain amount of a financial asset within a specified time. Put options assume that the security will drop below the exercise price before the purchase date.[7]

In times of uncertainty, options allow traders to limit downside while still enjoying upside. Traders can hedge a long position with put options, while short sellers can hedge a position through a call option.[8] Although options might sound complicated, they are actually the simplest financial assets to understand and apply. To learn more about how options can simplifying your trading, check out Vanilla Options by easy-forex.

[1] Ciara Linnane (November 27, 2015). “KaloBios short sellers facing squeeze as CEO Shkreli says will no longer lend stock.” Market Watch.

[2] GoFundMe.com

[3] Short Selling Definition. Investopedia.

[4] Philip van Doorn (November 27, 2015). “Opinion Why you should never short-sell stocks.” Market Watch.

[5] Chris Gallant. “How does a stop-loss order work, and what price is used to trigger the order?” Investopedia.

[6] Call Option. Investopedia.

[7] Definition of ‘Put.’ Investopedia.

[8] Complete Guide To Corpate Finance: Risk Management And Options – Hedging With Options. Investopedia.