The Modified Uptick Rule Debate 20 comments
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The following is not an argument for or against shorting, as that is a non-debate. The presence of short-selling is a necessary component of a free, liquid and healthy market. The question we’ll focus on here is what type of form the safeguards against abusive short-selling should take when the discussion by regulators takes place on April 8th.
First, a bit of background on the uptick rule:
The uptick rule, implemented during the last depression in the 1930’s functioned for 7 decades as a curb against most forms of abusive short-selling tactics. Essentially, it forced thos who wished to short a stock to wait for a buyer to come in before executing the sale. For no apparent reason, this rule was done away with at the peak of the 2007 bull market, and the end result was a field day for shorts who were now able to “slam dunk” a stock lower, meaning short more shares on each successive tick.
This led to cascading share prices for many stocks, specifically financials, a sector where the stock price action actually did have a very real effect on the underlying business of the company; if the shares of a fast food restaurant were being pummeled, that wouldn’t stop people from eating there, but would anyone want to deposit money into a bank whose stock was down 50% in a week’s time?
The heads of several regulatory bodies and major exchanges, including the NYSE and the SEC, have issued a joint statement that they will be bringing back some form of the uptick rule, albeit a modified one to take into account the fact that the original was written in a time before electronic order entry and day trading.
The main objection that many trading entities seem to have to the new proposal being kicked around is that there is language in there about restricting shorts from operating when a stock is down 10% or more in a single session.
I happen to agree with the detractors of this proposal. If you don’t restrict the buying of a stock that is up 10% or more, then imposing price restrictions on shorting would be hypocritical and would probably create more distortions of price and what one skeptic has called “synthetic short activity”.
An alternate proposal would be a push for more disclosure from shorts on their positions and trades so that regulators can detect and punish those with patterns of abuse and manipulation.
One other factor that should probably be included in any serious discussion of abusive short-selling tactics is the role that derivatives play in the manipulation of stocks. Many players don’t even bother shorting stocks when, with less capital, they can sell S&P futures contracts and e-minis, as well as use the credit default swaps market to produce the same effect. If you can sell enough call option contracts or spike up the put options, you can create the perception that something is “wrong” with the company. This leads to panicky shareholders and momentum traders doing the heavy lifting for you by obliterating the stock’s price on the way out of it.
As someone who does business with high net worth retail clients, I am often asked about the mechanics of shorting stocks and even criticized for shorting, as to some, the idea of betting against a company is un-American. My retort would be that shorting stocks, which theoretically carries a greater degree of risk because of the undefined downside (a stock can go up forever), should only be done by sophisticated investors. Further, nothing is more American than capitalizing on yur research and beliefs, and if this happens on the short side of a trade, so be it. Profits are profits so long as you are within the boundaries of good taste and the law.
And for the wingnuts arguing for no uptick rule at all…the Dow lost 8000 points give-or-take since the repeal. Granted, there were a host of factors involved that had nothing to do with abusive short-selling, but it certainly didn’t help matters that a handful of hedge funds were able to create panic at will. Don’t be a schmuck, we’ve learned about the consequences of a zero-regulation environment….10% unemployment and a 10 kajillion dollar deficit that your grandchildrens’ sperm and eggs will be paying off long after you’re gone.
I’ll be watching with interest and updating The Reformed Broker as news on the modified uptick rule develops. In the meantime, feel free to chime in below with your two cents…
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There are rules that limit options contract trading and the uptick rule is a reasonable way to protect a person or persons from "cornering the market" so to speak.
If the rule which was in place from the 1930's was not eviscerated during the recent unsustainable boom in the market place there would have been much less volatility in today's market correction.
The uptick rule does little during a non-volatile market though it does restrict the ability for a concert of effort to take down a particular security as has occurred in recent times.
Reinstituting the uptick rule does nothing to stop an investor in managing risk within their investment portfolio.
Wingnuts and shmucks indeed.
Yet the ignorant are demanding more power to these government thieves.
the madoff family compliance department were literally INTERMARRIED with the SEC staff
thx for reading
On Apr 06 07:45 PM Joshua Morgan Brown wrote:
> Neil, its not that gov't officials were on the take...in fact, its
> much worse...its that gov't officials were FAMILY
>
> the madoff family compliance department were literally INTERMARRIED
> with the SEC staff
>
> thx for reading
People are too caught up on the execution of a particular trade. The purpose of the uptick rule is to simply regulate the flow of transactions just as a stop light regulates the flow of traffic. The uptick rule worked perfectly well for 70 years. As proof, please research "uptick rule" communications during the ten years prior to 2007. Now compare that to the numbers of discussions post July 6, 2007. I rest my case.
While the issue is complex & I don't claim to be an expert, the simplest & best solution might be to require 1 hour delivery for short sells (T + 1 hour) and impose a steep fine for all violations. If the short seller really had the borrow before the trade, then he/she can deliver the shares within seconds.
While the ability to short is an obvious necessity, I don't see why the long and short sides have to be exactly symmetric. Why not make the short side a little less convenient with faster settlements or downside circuit breakers.
and must I balance all negative articles with positive ones in-between?
lol
thx for reading
On Apr 06 08:21 PM 123dawson wrote:
> Do I have to wait for another positive comment so I can make a negative
> one?
Obviously, the naked short is a greater problem, and that is actually already illegal, but as you've already pointed out, enforcement is the problem. So if the SEC arrests a few seriel abusers things may correct themselves, at least a little.
What is certain is that with the uptick rule absent the decent was faster than otherwise, to whatever degree. The hope is that the forces which exaggerated a move to the downside will also work in reverse.
Unfortunately, shorting is not simply the opposite of going long. It can be used to break a company, pick up the pieces, and sell for a profit. It is the abuses that are the concern, not the normal investment use. Such abuses are not practicable going long which is where the symmetry falls apart.