The Uptick Rule is Dead!

By D.R. Barton, Jr.

“We’ll take a short one-week break from our no-cost Internet sites series to go over a BIG regulatory change that has received very little fanfare.

Very few people noticed the recent death of the infamous short selling uptick rule. Let’s look at the short selling restrictions and then some implications that the removal of these restrictions are having for traders like you and me.

On July 6th, the SEC eliminated a 73-year-old rule that required an uptick in stock price before a stock could be sold short. In SEC language, they have removed the “price test restrictions” on short sales, and prohibited any other organizations from imposing price tests (local exchanges, for example).

An ‘uptick’ is the common name given to Rule 10a-1, under the Securities Exchange Act of 1934. This rule allowed short selling only following a trade where the traded price was higher than the previously traded price (called an uptick).

This uptick rule was the enemy of many a trader who tried to short a stock only to be “unable” on their fill or to get a much worse price than desired. It was one of the rules that made stock trading tilted to the favor of the long side. And it was especially difficult for day traders who wanted to trade NYSE or AMEX stocks.

What the Elimination of the Uptick Rule Means for Traders and Investors

This “quiet” rule change may turn out to have some interesting effects. Let’s look at how it impacts certain groups:

* Individual Traders and Investors. Longer term investors, especially those that only buy or go long will see little change in their activities. For anyone involved in short selling, there won’t be much change for NASDAQ stocks (earlier changes allowed legal workarounds for NASDAQ traders). But for anyone shorting NYSE or AMEX stocks, the change could have a significant impact on the ease of getting those short sales filled, since they will no longer have to wait for an uptick
* Institutions and Funds. A common practice for “big money” on Wall Street was to put in a significant amount of buy orders to move a stock to an uptick and then put in their real short sale order. Short selling will now be a more efficient endeavor for these institutions and funds. The elimination of this practice may already be affecting the Tick Index. (Thanks to Jason Goepfert for insights into changes that appear to be affecting the Tick Index already.)
* The Tick Index. The NYSE Tick Index gives the number of stocks on the NYSE that are trading on an uptick minus those that are trading on a downtick. This is a broadly watched index, especially among short and intermediate term traders. Since the uptick rule has gone into effect, many traders and commentators have noticed that the maximum tick reading of the day has been depressed. And this is easily seen mathematically: the average high tick of the day was 25% higher for the seven days before July 6th than the seven days since. This has happened despite the market’s move up, including the extremely strong move on July 12th. In fact, the 7-day moving average of the high tick of the day is at its lowest value since the sell-off that occurred in May 2006.

The bottom line is that traders and investors who use the Tick Index in their analysis need to be aware and wary of the skew in the index that is occurring. Monitor the Tick Index over the next couple of weeks to see if the this trend continues, and adjust your analysis accordingly.”

~ by Falcor on July 19, 2007.