Hedge funds are not “mutual funds” or “money market funds.” They typically manage money only for “high net worth individuals” which is a term defined by the SEC. So the people who have money invested through hedge funds tend to be at the top of the market food chain. Investment amounts go from $1 million up to billions of dollars invested by a single person or family. These are not individuals trading stocks online with Charles Schwab or E*Trade.

“Shorting” a stock means literally “borrowing” a stock that belongs to someone else, selling that stock on the open market, and then waiting to see if the price of that stock will fall. If/when it does, the “short seller” can purchase shares in that stock at the lower market price, “cover” the open position by returning shares to the owners from whom they were borrowed, and keep the difference between the “sale” and “repurchase” prices as profit.

Problems are created for “short sellers” when the price does not fall. As the price of the stock goes higher, the “short seller” must come up with the difference between the price it sold the borrowed shares at, and the price at which it needs to purchase shares to return to the original owner. If a short seller shorts a stock at $100 a share, and the stock goes up to $120, the short seller must come out of pocket with the extra $20 to buy the share to return it to the owner from which it was borrowed. That is how a “short seller” loses money.

When you buy a stock, you know it can only go to $0 so you are able to quantify your total risk from the purchase.

When you short a stock you cannot, in all cases, predict how high that stock might go — you cannot quantify your total risk from the short. That’s why shorting is different — and riskier.