What is the Uptick Rule?
by S. Wade Hansen Protecting Stocks from Short Sellers The Uptick Rule was originally created by the Securities and Exchange Commission (SEC) in 1938 to prevent short sellers from conducting bear raids on companies whose stock prices were falling lower and lower and lower. Sixty-nine years later, at the end of 2007, the SEC dropped the uptick rule. However, there are rumblings on Wall Street and in Washington that the uptick rule might be brought back.
The uptick rule is a rule which states that people cannot short sell stock during a downtick. In other words, the value of a stock must be rising when someone makes a short sale. This practice is designed to prevent a cascading effect in which short sellers “pile” onto a stock to drive the price down for the purpose of profit. Like many regulations in the financial industry, the goal of the uptick rule is to prevent unfair market manipulation which still facilitating open trade. Short selling is a complicated process, and it’s easy to get in big trouble as a short seller. When someone makes a short sale on stock, he or she borrows the stock from someone else, and sells it to another person at a set price. When the price of the stock falls, the short seller buys back the stock at the lower price, gives it back to the original owner, and keeps the difference in price. If the value of the stock rises, the short seller will be forced to pay extra to cover the sale, which is what makes the
The Uptick Rule states that you can only short – sell a stock, if it trades higher than its previous transaction price. So if AIG traded at $4 and then at $3.95, you can’t short – sell it. You can only short sell it, if it trades higher than $4. In short, you can short – sell it, only if there is an “Uptick”. The Uptick Rule was introduced in 1938 in the United States and was eliminated in 2007. There have been calls for re-instating the rule, especially with all the volatility and panic in the markets. There has been vocal debate on the utility of this rule and whether it serves any purpose at all. There are several factors that you have to keep in mind when looking at the uptick rule. In the Long Run The SEC banned any short – selling in financial companies for a brief period between Sep 20 2008 and Oct 2 2008. This was done to reign in price volatility and help the stocks of financial companies. During that time period Citi moved up from $20.65 to $22.50 and AIG moved down from $4.7
The tick is a change in price. A stock is said to be on an uptick when the last price change was upward. The uptick rule said that short sales could only be made on stocks with an uptick. This was to prevent short sellers from forcing a stock into a nosedive. It was more of a limit when shares traded in eighths (12.5 cents per tick). Now, with shares priced in cents, nobody has to wait long for an uptick, so the rule didn’t do much except make for compliance problems with computer systems, so it was eliminated in the US a couple years ago.
There is talk of resurrecting the uptick rule – Bernanke Says There May Be Benefit to Resurrecting Uptick Rule. What is it – 1. Investopedia defines it as – A sometimes rule established by the SEC that requires that every short sale transaction be entered at a price that is higher than the price of the previous trade. ” The rule was introduced in the Securities Exchange Act of 1934 as Rule 10a-1. The purpose of the rule is to prevent short sellers from adding to the downward momentum an asset is already experiencing sharp declines. The SEC eliminated the rule on July 6, 2007. It is also known the “plus tick rule”. There are calls to bring back the uptick rule.