With the current economic downturn, many financial analysts and experts are still pointing fingers at each other with the hopes of discovering the cause of it all. The failed housing market and conniving executives could be partly blamed for the financial crisis, but many feel that short selling on the stock market has been a major thorn in the side of Wall St., which, as a result, has greatly contributed to the crippled financial state of affairs. There is recent talk that the SEC will attempt to extract the painful thorn by reinstating the Uptick Rule.
What exactly is the Uptick Rule? It’s simple. Those who want to short sell a stock will only be allowed to do so if they short it at a price higher than its previous trade value. If you’re not sure what short selling means, it’s even easier to understand that the Uptick Rule. Short selling stocks is the opposite of buying stocks: you’re betting that the stock will go down in price. However, it’s not always easy to short a stock and make a profit. First, you have to find a broker that will accept a short sale of the stock. This means that the broker is willing to lend you the stock for a certain price, and that they’ll accept payback of the stock at a lower price. The broker, though, might only have a small amount of shares available. Additionally, the broker may put a limit on the short sale, a month. Here’s an example:
You believe that Company X’s stock isn’t worth its current price of $10, because it has been dropping every day for over a month. In fact, you feel that the price will continue to make a drastic fall in value. So you go to Etrade, and find Company X’s stock. Turns out, Etrade has only a hundred shares for you to short. You initiate the transaction, which means Etrade has now given you a thousand dollar loan against the stock (obviously, your account would have to have a balance much larger than a $1000; broker’s don’t just hand out cash that easy). Good news, the stock value continues to drop for the next two weeks to $5. You decide you want to cash out, so it’s time to pay back the loan. Luckily for you, the hundred shares are only worth five dollars: your loan payoff amount is $500. You keep the other $500.
The Uptick Rule will definitely not cause a complete reversal in the market, and it will certainly not hinder folks from short selling altogether. To be honest, in my experience, most short sellers’ profits are made the day after a stock has gone up in price. Whenever a low-value company’s stock jumps in price for no good reason, you can almost count on it dropping a small percentage the next day. I just shrug my shoulders at the return of the Uptick Rule. It won’t stop me from spotting an easy short sell and striking when the time is right.
Investopedia Uptick Rule Definition
