No Uptick Rule: A Convenient Scapegoat?

From the “you have only a few more days to kick me around” department: I’ve written here previously about the uptick rule and whether it is the cause of all that ills the financial world, er, the stock market.

I won’t sit here and argue whether it should be reinstated. The markets have clearly become more volatile, and some stocks, like Bear Stearns (BSC), have been obliterated.

But is the lack of an uptick rule to blame?

Several points:

1. There don’t appear to be any solid studies on the subject. Barry Ritholtz has a good chart here that shows volatility definitely has increased since the rule was fully eliminated in July of last year. Ironically, he points out, if shorts are fast to cover, the volatility would appear to be very much on the upside.
2. Many people forget that a pilot program on the elimination of the uptick rule went into effect on 1,000 highly liquid stocks in the summer of 2005. At the time, as Bespoke Investment Group points out, Jim Cramer, one of the most vocal proponents of reinstating the uptick rule and one of the truly very smart people I have known, wrote:
   

   This rule change, of course, couldn’t come at a worse time. The market’s terrible. Longs are beleaguered, shorts are emboldened. I think it is fair to say that things are about to get a lot worse, a lot faster for the stocks of bad companies without the slowdown circuit breaker of the uptick rule. But the SEC, in its non-infinite wisdom, dreamed this little doozy up and all I can tell you is that you ain’t seen nothing yet.

   
   As it turns out, the stocks of good (and bad) companies continued to enjoy the tail-end of the bull market, as stock prices rocketed for two more years.
3. While it would appear to have been a pile-on by shorts when the stock of Bear Stearns blew up, Bear Stearns was already a favorite short because of its high leverage.
4. If they were to reinstate the uptick rule, shouldn’t there be a downtick rule? Wouldn’t it help eliminate the stock melt-ups and bubbles? Oh, I forgot: It’s okay if stocks go too high and investors who get caught up in the momentum get hurt; it’s not okay if the damage occurs with stocks going the other direction.

Reality: The markets probably ARE more volatile because of the lack of an uptick rule. But the volatility is likely exaggerated by the combination of the housing and related financial upheavals. The rapid decline of a stalwart like Bear Stearns has everybody looking for a scapegoat. The uptick rule would appear to be the most convenient.

Just remember, however: Even with the uptick rule gone, the free markets have prevailed and the markets have survived and, according to many bulls, are poised for a rosy future.

That’s my 2-cents for today. Agree? Disagree? Comment away.

Comments

[mrtaxx]

Herb,
You lost me with the name Cramer, your buddy. Cramer has lost so much money for so many people you should be ashamed of yourself. Granted Cramer knows a lot of stocks and their past. But his future predictons are best left to the dartboard, he knows what we all do about a stocks future direction, NOTHING. Then there's his disclamer about how his predictions may have been previously disseminated, give me a break, his buddiesn and relatives already know what he is going to say. Geeee I wonder if they will trade on this information?

The article is about the short tick rule, to this I say the Markert Makers rule, not the short tick ruel.

[mrtaxx]

Please excuse the spelling error, buddiesn=buddies, and any other misspellings.

[stonedinvestor]

Boy herb I have tried to listen to you in the past but this comment boggles the mind- Jim Cramer, one of the most vocal proponents of reinstating the uptick rule and one of the truly very smart people I have known. Have you lost your mind? No one will take you seriously again. Fools approve of fools I guess.~ stoney

[lobsterboy]

I agree with the article, no uptick makes for a more free flowing trading market. The problem still rampant in trading markets which is normally thrown under the rug: short locates.

Naked shorting is the problem, not shorting on a down tick.

[ponchovilla]

From what I read the naked shorting is potentially a bigger problem than the uptick rule. Will we ever find out with the SEC?
Here's a bit of worthless advice: Don't ever mention Cramer or Kudlow in an article again. I personally enjoy what you write and the opinions you express on the "clown" shows. You get lots of attaboys. But as a wise old sage said to me "one ashit wipes out 1400 attaboys."

[WACG]

My respect for your opinion dropped a couple of notches when you associated yourself that Toilet Bug Cramer. Why contaminate yourself by mentioning that self-serving ego maniac? sad ... very sad

[CM in MA]

Herb, I'd recommend folks take a look at a chart of the VIX from mid-1998 to early 2002. Now that was volatility, and the uptick rule was alive and well. There is no correlation between the existence of the uptick rule and low volatility. Likewise, there will no doubt be little or no correlation to the lack of an uptick rule and high volatility. I have nothing against short selling (or short sellers). The only thing that bothers me is that short sellers can hide their activity due to the delayed reporting of short positions. Shorts should have the courage of their convictions and operate in full view. Mark the ticket and ticker as a short sale so that the market has full, real-time knowledge of short interest.

[adan]

herb, can you do a follow up, w/more info, maybe also using the historical correlation/non-correl... (1998-2002) mentioned above?

also, what effect, if any, the short-etf's may play? they're out in the open, non-hidden; so i'd think that's a good step

and one last also :-) aren't there reports (verifiable?) that were a lot of last minute puts taken out on bear stearns right before they went down? wouldn't that have an effect and be a part of why it crashed as it did?

thanks!

looking fwd to your future takes on things; at least i hope you'll be continuing to comment etc

[ViewfromNYC]

The demise of the NYSE floor probably has more to do with the increased intraday volatility for NYSE stocks. Formerly, the specialist would stabilize prices and help eliminate the effect of the different times to market of buy and sell orders. The specialist and floor traders disseminated information, like which brokers had shares to buy or sell. Also the introduction and refinement of algorithmic trading has removed liquidity from the market. No longer are there sizable orders lined up on the book. Finally the legions of mediocre 'traders' for mutual funds are happy with a VWAP execution, a few thousand shares at a time to get the average price, rather than trying to actually profit from trading prowess. Unsustainable stock prices will always correct. In the short term, investors should have the fortitude to trade (buy stocks) when the evil short sellers execute a bear raid. Long term investors have nothing to fear from short term volatility. No company was ever driven out of business by a bear raid. Short sellers on the other hand have been carried out by company initiated short squeezes.

[BlogCruiser]

Volatility goes up and down for lots of reasons and there is absolutely no reason to think that the demise of the uptick rule has anything to do with the recent climb in volatility or the demise of Bear Stearns (greed has everything to do with the latter).

I see no reason for having an uptick rule. Betting on a stock falling in price is about as fair on betting that it will go up in value.

[Dr A J]

Study why the short sale rule was originally initiated.Instead of groups of moneyed interests banding together for their own purpose of forcing a stock down ,making the stock look bad,causing more selling and liquidation,large hedge funds can more easily manipulate now without restriction.
Look at the risk- reward,what benefit is there to the investment community by removing the rule?None ,just making markets less orderly.

[cyberman]

HG: How about you take on Cramer's view on another SEC failure- where short sellers sell short without actually borrowing the stock? And is the demise of the uptick rule and seling short without actually borrowing the underlying stock to do so related in your mind?

[fxtrader07]

Herb, you are a poster child for bad journalism (i.e. cooking negative stories about specially targetted companies all day that were told to him by his hedgefund friends and masters). Now, switching to a "analyst career" you stop pretending being a jourmalist any more. or so i hope at least.
Now you can directly provide your "independent"... bashing "research". Not much will change, though. Your naked short selling friends (uh, oh, naked short selling doesn't even exits, right, Herb? Too bad for you, that even the SEC regards it as a huge problem by now) will call you up as usual telling you the stories as they need them to destroy ever more companies with false allegations and cooked-up "research".

[peytopolo]

fxtrader07
Very well said