The Uptick Rule: Helping Stop the Downfall

The SEC chairman announced the plan to restore the uptick rule. Restoring this rule should return a little bit of confidence back to the market while helping keep the market from any sudden plunges. Let's take a quick look at the uptick rule and how the markets reacted when the rule was eliminated.

The uptick rule was formed back in 1934. The rule allows short sales only when the last price was higher than the previous price. If you wanted to sell GE and the bid was at 8.25, you would have to wait until the bid went up to short GE. You would probably want to put a limit at 8.27 so when the bid went up, the short immediately went through. This relieves stocks of sudden downward pressures to cause the stock price to plunge by requiring the stock to go up before you short it. Notice that the rule was initially formed in 1934 right after the 1929 crash. This rule was eliminated in July of 2007. We have not seen a fall like we have experienced over the last 6 months since the Great Depression when we formed it initially. When we saw firms like Bear Sterns and Lehman Brothers fall uncontrollably, the uptick would have slowed the decline and maybe saved some investors from steep losses.

The uptick rule should not be confused with naked short selling. Naked short selling allows the seller to put pressure on stocks without even buying the stock first. The ban, which was temporary and ended last fall, made the seller actually acquire the stock before shorting. This also relieved many financials from sinking too quickly. The uptick rule only applies to stocks, not ETFs or futures. Short selling is a very risky strategy. If you buy a stock and have it go to zero, you only lose what you invested. Should you short a stock and have it go up, you could lose much more than you have. I do not short and will not short, even in a bear market. Their are always bulls to be found. Should you find them, you do not only limit risks buy limiting your losses (unlike short selling), but you have a great opportunity to make cash money.