How Much Can We Blame the Uptick Rule?
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There have been a number of headlines in recent weeks on whether or not the elimination of the uptick rule (a stock no longer has be shorted on an uptick) in July of last year has contributed to the market's declines or at least the pickup in volatility. While it is hard to argue with the fact that volatility has picked up since July, it's important to remember that the no-uptick rule was in place for a large number of stocks as the market charged higher from the middle of 2005 to 2007.
Way back in 2004, the SEC announced that it would suspend the uptick rule on designated securities in the Russell 3,000 as a pilot to see how the stocks and the market would react. The pilot ended up consisting of about 1,000 stocks and didn't go into place until May 2nd, 2005, with an expiration in April 2006.
While the pilot didn't get much coverage when it was announced or finally put in place, here is an article from The Wall Street Journal back in 2004.
If the no-uptick rule was really the root cause of the market's declines and increased volatility, shouldn't the market have struggled much more than it did from mid-2005 to mid-2007 when the pilot was in place? The pilot consisted of 1,000 highly-liquid stocks that all had associated options. Below we highlight a chart of the Russell 3,000 from 2004 to present. Had you looked at the chart in July 2007 right before the uptick rule was officially eliminated, one could make the argument that no-upticks across the board could make the market go higher!
Jim Cramer has been all over this issue in recent weeks as an opponent to the no-uptick rule. While some may think he's irrationally blaming the market's declines on the no-uptick rule, he has in fact been criticizing it for some time now, and his commentary definitely suggests that other issues are contributing to the fall. But after a Google search, we did find an ironic article that he wrote just prior to the pilot period. Below are some excerpts from the article that he wrote on April 29, 2005:
"Just when you thought it couldn't get nastier for the "longs" out there, the people who just play from the long side, the SEC passes the Hedge Fund Relief Act, and it goes into effect Monday. Oh, it's not called that. It is just the suspension of the "uptick rule." But it certainly will have that impact, for both the hedge funds and the market.
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 shown in the chart below, his "couldn't come at a worse time" comment actually came at a great time to buy stocks, all but disproving his argument for the next few years.
While the no-uptick rule might be contributing to some increased volatility, it's hard to blame it (and not the other glaring issues) for the downward pressure on the market.
We're in the process of analyzing the performance of all the stocks included in the pilot program to see how they traded versus stocks that weren't included during the effective period. And by the way, BSC was included in the pilot.
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This article has 25 comments:
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Wez
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172 Comments
Apr 04 04:58 PM-
haydete
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66 Comments
Apr 04 05:05 PMSeems with all the discussion of the VIX, 3% daily swings, investors staying out of the market, that the cast would vote for less volatility.
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nitroae23
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13 Comments
Apr 04 07:31 PM-
farsighted
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5 Comments
Apr 04 07:59 PM-
hollowman
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24 Comments
Apr 04 08:00 PMSeriously, the case against them has to do with bear raids and that is a bit overdone. As someone who is picks a stock that they are willing to stick with for years bear raids are
a) a little annoying if I'm already in the stock - but I can always add more
b) very beneficial if I'm waiting for a stock to come down a bit.
In the end, bear raids don't affect the long-term performance of good quality stock.
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doulos
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2 Comments
Apr 04 09:07 PM-
in4thelonghaul
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18 Comments
Apr 04 09:45 PMYou first need to educate yourself regarding the whole "naked shorting" epidemic and understand that the reporting of such 'failures to deliver' is voluntary and currently completely tolerated by the SEC stooges. The combination of FTDs and bear raids fascilitated by uptick elimination is rapidly turning the market into a rule of the jungle casino which will eventually lead to a mass exodus from American exchanges by both companies and individual investors.
I trade professionally, specializing in biotechnology stocks; this niche along with microcap technology has been especially hard hit by the SEC's absurd decision to eliminate the uptick rule. Remember, there are lies, damn lies, and then statistics...ask any honest professional pollster. Those so-called test securities which you allude to don't prove anything. I am tempted to speculate that only an couple of eggheads with little actual trading experience would cite that stuff in the face of real world experience. I guarantee you, from first hand experience, until the SEC seriously acts to eliminate the possibility of naked short sells...I mean "serious" as in felony status, jail time, and/or very severe fines for offenders, the uptick rule is absolutely needed; even then it should be reinstated immediately.
Those who say that bear raids don't affect long-term performance of good quality stocks are either naive, inexperienced with small cap stocks which are favorite targets, or simply individuals who are often short. It is one thing to bring a well capitalized large cap stock down 10 or 15 percent...quite another to bring a financially strapped biotech micro-cap, which may be working on a cure for a deadly cancer, down 60 or 70 percent and then hold it there for weeks or months...damaging investors and starving it of the possibility to raise capital at realistic rates.
It is said that a little knowledge is a dangerous thing...those who honestly don't recognize the need for the uptick rule have little knowledge, or they simply find the uptick rule an impediment to their goal of making money.
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jcrash
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256 Comments
Apr 04 10:05 PMBTW, they target more than just small-caps. If you don't think NVDA losing 60% of it's value in 2 months after 7 quarters of record earnings and on no news whatsoever wreaks of manipulation, I don't know what does.
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spragus
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13 Comments
Apr 05 08:39 AMBut it is a good question. Has anyone seen a decent study of the effect of removing short traders' shackles (elimination of the up-tick rule and the SEC's generally ignoring naked shorting)?
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Fred from Michigan
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22 Comments
Apr 05 09:41 AMWhat was the result of the 1000-stock pilot study? Did these stocks behave differently as a result of removing the uptick rule? Goggling "uptick rule pilot study" will get you to relevant articles, eg,
www.helium.com/items/5... . The general conclusion seems to be that neither volatility nor return were changed.
However, "Unfortunately, the study did not examine the consequences for low float stocks (stocks with few number of shares traded daily) and small cap stocks, which are targets for manipulation."
I don't know my away around stock manipulation, but it seems quite possible to manipulate on the upside too. Why not have a "downtick" rule to prevent manipulation on the upside? Just kidding in a way, but perhaps a "tick" rule is the wrong way to solve these problems.
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dukeb
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20 Comments
Apr 05 09:57 AM-
GKM
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173 Comments
Apr 05 11:03 AMFurther, how many hedge funds made money on the rumors of MBIA and AMBAC getting a bail out back in January? How many shorts were squeezed by those unfounded rumors? Oh but that's okay since, even though those are really bad companies who've made a lot of mistakes in the past, you shouldn't be able to speculate that they are/were over valued?
Guess what - owning stocks is a speculation that they are at worst fairly valued and, even better, under valued. If you don't own a stock, you are in a de facto short position since you must believe it is over valued. If you actually go and short a stock, then you are putting more than opportunity cost at risk. Similarly, if you go and buy a stock, you are putting money and opportunity cost at risk.
There needs to be symmetry for any market to function. If there is no symmetry then that market will be skewed and ultimately will result in inefficiencies which the market will then find a way to sort out in some perverse fashion. Maybe the crash of '87 is the perfect example of that given the uptick rule was in place then. Buyers didn't want to buy and sellers couldn't sell so the market came to a virtual standstill. If you'd bought that dip, you'd have been up 50% in one year. Was that a bear raid (with the uptick rule in place) or just one hell of a buying opportunity?
Markets don't come to an end and they won't stop going up in the long run (especially with the Fed printing money like there IS no tomorrow). Just ask Warren Buffett with his put sale strategy. Next time someone yell's bear raid in a crowded theatre and you have any doubts about the validity of that, you should be in there with both fists loading up for the long haul.
It is interesting that the ones who seem most put off by the elimination of the uptick rule are purely long-side traders and not investors. I would bet if you ask Warren whether he cares about the uptick rule or not you'd get a vastly different answer to that of Jim (the Wealth Destroyer) Cramer. If you want to trade this market, trade it and quit whinging about the inequities of market.
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HalB
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4 Comments
Apr 05 12:01 PM-
Ed Ryan
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1 Comment
Apr 05 12:43 PMWe traders used to have to put on bullets or conversions to hit a down tick. Bullets were made illegal and now are of no consequence.
When making governmental decisions, we should always error on the side of freedom. If someone wants to hit my bid – more power to them. It doesn't matter if that seller is a long liquidating his position or a new short. Buying is buying and selling is selling. Price discovery is all that matters.
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HittheBidE
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1 Comment
Apr 05 01:05 PM-
spragus
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13 Comments
Apr 05 01:07 PM-
Rep07
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12 Comments
Apr 05 03:56 PMWe have to prevent "naked longs" from driving stocks up in a frenzy. It's blatant market manipulation and it's increasing volatility in the market. Look at what happens with GOOG, FSLR, etc.--too many investors are being hurt because out-of-control buying is allowed without comment. Longs buying on upticks should never have been tolerated in the first place, it's the single largest cause of investor losses and excess volatility.
Any questions?
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Purl Gurl
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34 Comments
My Website
Apr 05 10:45 PMYou are afforded an opportunity to comment on naked shorting through the SEC web site. The SEC is requesting comment on proposed rule changes related to naked shorting. This is your chance to make a difference.
Main page for proposed rule changes:
www.sec.gov/rules/prop... (top rule - naked shorting)
Your comments can be submitted at this web page:
www.sec.gov/cgi-bin/ru...
8-08&action=Show_F...
Already submitted public comments can be read here:
www.sec.gov/comments/s...
My submitted comments are available here:
www.sec.gov/comments/s...
Rather than complain, take action.
Okpulot Taha
Choctaw Nation
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Mike Pogue
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3 Comments
Apr 06 01:21 AM-
DougM
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113 Comments
Apr 06 01:43 AM-
Vladimir Senkov
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88 Comments
Apr 06 01:47 AMif the rule had visible effects, such effect would mostly be felt on equities with limited liquidity and such effect is also likely to be temporary.
having said that, i don't believe this particular rule is what is needed. if the problem they are trying to fix has to do with "bear" raids or hedge fund activity, then why create a rule that only applies to the short side? why not control the problem at the source: regulate use of leverage, as in "reg T".
it looks like individual investor is already regulated well in that regard. If hedge funds are a problem, add some regulation there instead of trying to invent a bogus rule like an uptick rule. what's next? no selling after the "double top" pattern has been formed? :)
so i'm glad they have gotten rid of this rule some time ago, but it looks like they didn't do enough regulating leverage, or we wouldn't be having these funds (i mean gamblers) losing their 32-to-1 leveraged MBS bets.
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PCScipio
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33 Comments
Apr 06 01:00 PM-
tomc368
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6 Comments
Jun 07 09:19 AMThe very essence of short selling goes against all principals of any market. In an apple market, have you ever seen a grocer sell 100 apples to someone and he didn't have the apples to give? Maybe he can borrow the apples from someone else to sell? Well if he can, he damn well better deliver those apples upon sale. Maybe he can borrow the apples from someone else who does not even know that he is borrowing the apples from him! (aka stealing).
Shorting on downtick would be OK if you had to borrow the shares to do it. The problem is naked shorting on the downtick where you don’t have to borrow shares first. Guess if you have the financial backing of hedge funds it is OK. They can throw massive amounts of naked shorts on a stock, and cover shorts along the way. End of day, they have covered their short position and laugh all the way to the bank.
The theory of the short sale is acceptable. The problem is that the theory and fact are not the same. The locate and settlement processes do not work and are not controllable. The theory of short action is to offest long action. The problem is the current system allows shorts more time and leeway than longs so the process is unbalanced. It is not the theory of shorting that is the problem, it is the locate and settlement proccedures that are the problem. The shorts and longs are not equal as the theory would have us believe. Naked short selling is being done all of the time and it is unfettered. Hedge funds with loads of money can throw it at a stock and overwhelm the longs. They can affect their play and settle before it can ever be noticed a naked short sale took place. Until you can get fact and theory to be the same, short sales will be a problem to the stability of the market. I only wish more people would speak out on the issue. Since most people do not short, they are not aware of the problems or how they are being affected by them.
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To_News:
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3 Comments
Jul 07 01:45 PM-
Bob McGregor
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9 Comments
Jul 14 07:56 AMScrip borrowed and naked short selling [SS], without observance of the up-tick rule, has help destroy world wide markets ever since the USA SEC removed the up-tick rule early July 2007. It's more than coincidence that the majority of World Exchange Indexes were sold off in 2 major down waves shortly thereafter; namely July to August 07 and Oct/Nov07 to present date. The excuse the SEC gave for removing it was a study done over the prior 3 years from which they concluded it would not deleteriously affect the USA markets if removed. It had been in place since 1938 because a study following the 1929/1933 crash concluded the extent and speed of the fall was directly related to the fact an up-tick rule was not in use within USA stock markets. It was further concluded, correctly, that the introduction of an up-tick rule would create a fairer and more transparent environment in which to trade stocks. Such was the case until it was withdrawn early July last year.
Of course the SEC study on which their recent conclusion was based was FLAWED, as it was carried out during a major worldwide bull market. No doubt greedy brokers and very sophisticated traders such as hedge funds - were agitating the SEC to have it removed as they realised trading NIRVANA would be at hand should they succeed. One only has to observe the carnage since it’s removal to realise the SEC made a MAJOR mistake.
This was particularly so in Australia where scrip borrowed short selling was not "subject" to the up-tick rule even though naked short selling was. In reality, legal opinion surrounding scrip borrowed SS concluded it did not have to be reported, as that opinion suggested that upon borrowing stock, legal title passed from the lender to the borrower. Consequently the stock could then be sold anyway the NEW “owner” deemed and certainly not by observing the up-tick rule, as their prime intention was to destroy the price and possibly the company as well.
If ALL short selling was made transparent [reported daily] and observed the up-tick rule, the TRUE EXTENT OF SHORT SELLING WOULD BE known. It is grossly understated in the major Anglo Saxon markets and caused the extent of the falls in Australian financial stocks.
What makes the whole SS exercise highly desirable in Australia is fact that profits from scrip borrowed short selling were not subjected to TAX, as an anomaly exists in the Australian Tax Act, when altered in 1987, to help offset the delay in delivering scrip when the Australian system changed from a paper to an electronic settlement - using a new system called CHESS. This coincided with the introduction of screen trading in 1987 [end of floor trading]. It has not been revisited since, with cataclysmic consequences for Australia as overseas HF’s decimated the stock market over the past year.
A further variation on the SS theme is “pairing” where quant analysts determine the strength or weakness of stocks and elect to buy the strong, simultaneously SS weak stocks to various designated formulas. It can be instituted for a very low cost – around 50 basis points to borrow the weak stocks - and the sale proceeds of the SS leg are used to buy the strong stocks. Such pairing saw financial stocks being SS while Resource based stocks were purchased – all for a cost of 50 basis points. Spreading false rumours was also part of the game to maximise profits. This creates massive gearing and is the next major bubble to be pricked. Consequently, a SS cap of say15% per company stock should also be put in place otherwise massive dislocations could result in the markets.
Indeed, trading NIRVANA has existed since the SEC removed the SS up-tick rule, which had served world markets effectively for the past 69 years. It should be reintroduced immediately, accompanied by daily reporting of all short positions current in each stock. Transparency must be demanded of all participants and a SS cap created to limit the short interest in designated stocks to say 15%. The World SS BUBBLE would be pricked and stock prices would return to realistic levels.