I take it by your reference to liquidity you are refering to short selling and not the rest of the products. For reference shorting is just as legitimate as going long. Shorting could not bring down the whole financial system. In fact quite the opposite. Imagine being a shareholder in a company that has just had some bad news and there wasn't a single short open on that sock. Depending on the situation, that stock could potentially go to zero or very close to it before anyone could sell. Leaving only the most highly speculative punters willing to buy in at the bottom. Remember the short HAS to buy back in to take profits when he gives the shares back. A short seller is just as big of a speculator as the long and should not be deamonised. Large companies taking large enough positions to affect the whole market are supposed to be already regulated.
For futures, options and CFD's this is exactly the process. It is the job of the clearing house to settle margins. Margins are balanced daily, and if your position goes into the red, you cough up each day to balance your margin, and keep coughing up each day the further out of the money your position goes. As soon as you fail to pay your margin, your position is sold to balance your account.
Yes this is what I mean for short positions. When you go long you have to stump (aside from a margin loan) the full amount upfront and 100% of that is at risk. When you go short, the potential losses are limitless and you don't have to stump up a cent until it settles. If that means you are bankrupt in the millions what happens then? I was thinking along the lines of a margin of collateral relative to the stocks volatility. For example: if a particular stocks largest daily move in the last 12 months was 5% in either direction. Then the original amount of the short plus 5 % needs to be held as collateral. So if you want to short 100k of a 5% "volatility" stock, you stump 5k of your own money and add that to the 100k you get for selling the stock short and it all goes into escrow. If the short breaches or comes within 10% (in this case $500) of that 5k collateral, the short seller needs to come up with another 5% to keep the short sell open. Maybe I have spoken before thinking this through thoroughly but surely there has to be some form of protection in a standard short.
My broker enforces a collateral buffer for short selling of shares. However, it is much easier to just use CFD's as a retail pleb.
