The SEC Uptick Rule Change: Bad Timing for a Bad Idea

Jim Cramer is currently discussing the SEC's change in the "uptick rule" for short selling.  Ticker Sense and Birinyi Associates has focused on this rule change since November 15, 2007 when we first highlighted that this rule change was causing fundamental changes in market activity. 

We continue to agree with Mr. Cramer, although we may say that he now agrees with us.  Nothing illustrates the underlying change better than the peak in Dow's non-block money flow chart.  Birinyi Associates is known for its money flow analysis, which is an analysis of each transaction in a stock and shows underlying activity behind seemingly small price moves.  As shown, the Dow's money flow peaked in July of 2007 and has declined ever since.  Short sales that can now be executed on any trade have caused the money flows to turn and this is also a reflection of the rule's impact on market activity.

In addition to the dramatic declines in money flow, the VIX and average daily change for S&P stocks have also increased since then.

Changing the uptick rule certainly did not cause the subprime meltdown, and would not have prevented a decline, but it has caused increased volatility and declines in stocks that would not have been so dramatic.  In essence, short sellers are now able to sell stock that did not previously exist.  While there is a buyer for the stock, essentially increasing the number of shares outstanding and offering those shares at a discount has caused stocks to fluctuate wildly.  Since large amounts of capital are required to play this high-stakes game, many players have been driven out of the market.  Investors have taken refuge in gold (peaked at $1,000/oz), and treasuries (10y yielding 3.31%). 

Investors interested in this kind of market insight well ahead of its appearance on CNBC should consider investing in one of Birinyi Associates' research products detailed here.

Comments

[Bruce Brotnov]

I have been following the problem since 6 July and started a post on IBD thread on 2/12/08. The more people that recognize it and complain about it, perhaps the SEC will do something to level the playing field. It don't have to be the same "uptick", but something needs to be done as short sellers have a free license to steal from investors.

[HOWARD HAVLIK]

I think abolishing the uptick rule has caused me to lose about $12,000 since it took place in NOVEMBER of '07

[HOWARD HAVLIK]

I think that your organization is working only with the hedge funds rather than for the goo of the economy and the market.

[howard havlik]

PLEASE REINSTATE THE UPTICK RULE FOR PUT OPTION TRADERS.

[howard havlik]

PLEASE REINSTATE THE UPTICK RULE FOR PUT OPTION TRADERS. THANKYOU

[Dirk Darlington]

"In essence, short sellers are now able to sell stock that did not previously exist"

The stuff here is normally pretty spot on and well researched but that post above is just at best naieve and at worst totally false.

It works the same way only instead of waiting that extra 5-10 seconds to get a fill, you can get it immediately. On occassion when a stock is getting hammered you might have to wait a bit longer but there are hundreds of upticks in stocks each day even the ones that go down 50% in a day. Pull them up and look at them. Its penny increments. Upticks everywhere, Dowticks everywhere for that matter.

The SEC studied this issue at great length and numerous papers have been written about this. Some in great depth.

With the advent of decimal trading, ECN's, Dark Pools, and algorithim trading the uptick rule didn't do much anyway but with new strategies like 130/30 and portable alpha stategies it was increasingly clear that the strategies were being penalized by that archaric rule.

As it was the nasdaq rule was less restrictive than the NYSE's so more volume was flowing first to Arca, then to dual listings on other exchanges.

Reg NMS further complicated compliance because not every market center had the same "up tick" requirements. Hitting someone with a less restrictive policy, gives someone a potential advantage of the other person that chooses to send his order to say super dot.

As to the conclusion that it has something to do with the decline. Correlation does not imply causation.

Anyway, I would suggest the author of that post read:

http://www.crestmontresearch.com/pdfs/Stock%20Volatility%20Return.pdf

http://www.sec.gov/rules/final/2007/34-55970.pdf

Particularly the latter one in full so they understand why the change was necessary given the financial innovation that has taken place the last few years.

If they changed it back the market wouldn't be any higher than it is now. Uptick rule or not the market is going to go where its going to go, it did in 2001 and it has this year as well.

What should they change it back to anyway? Should the nasdaq way be the standard or the NYSE....or both? (higher bid or higher print?).....

for that matter why a penny....maybe they should make the minimum increment a full nickle that has to be better than a cent. I say no shorting unless the stock is atleast a nickle off the low of the day.

How's that?

Seriously......read some of the papers the SEC commissioned on the subject, they don't go around removing reglations that old with good reason.

[SS]

This is one of the biggest scams that has ever been put upon the investing public. Allowing a free hand at bear raids is stupid as a bag of hammers....one of the many that have been blessed during the Bush admin. It's right up there with Ethenol subsidies

[gamma]

Hmmm, have we had insanely large percentage declines on a daily baiss? weekly basis? monthly basis?

No we have not. To say that removing the uptick rule has increased volatility is laughable. The simple data doesn't support it.

I also find it laughable that people say they have been "fleeced" because of short selling. Hardly. They have been fleeced becasue they made poor choices by keep money in companies that took too much risk.

Some things never change. Everyone wants to blame politicians (they are dirt bags for the most part), but hello - they are elected by the people and for the people. They are a reflection of us. Fat? Dumb? Greed? Incompetent?

Look in the mirror, those of you complaining and see the dumb fatass saddled with debt staring back at you in the mirror.

"We have met the enemy and he is us."

[gamma]

I'd also add - look at China where short selling is illegal. Their market is down 50% in 6 months.

Look at the 1929-1935 period - market down 80% and there were vvvvvvvvvery few shorts.

When everyone is on the same side then their is no natural buyer for the sellers (longs) to sell to.

Be careful what you wish for... and don't forget to take responsibilty for yourself.

[hkn]

no one remembers Lehman. Who killed the stock price? Who killed the bank prices. WE need the uptick rule to help the small investor. Hedge funds made billions. I hope they all fail.

[Thomas Sokalski]

yes....please reinstate the uptick rule

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