How the Uptick Rule Changes Everything for Investors

The uptick rule is likely the key to what’s happening now and for many years to your investments.

In 2007 the government suspended the uptick rule, but now they think maybe, just maybe, they made a mistake.

First, what is the uptick rule and why should you care?

The uptick rule was put in place by the good folks at the SEC in 1934.  The rule required that if an investor wanted to “short” a stock, he or she could only do so at a higher price than the previous trade.  For example, if a stock was trading at $15, you would have to bid over $15 in order to sell the stock short.   The impact was that you could not sell short while a stock was in a free fall.  This was really important.  It made it very difficult for speculators to add to the downward pressure of a falling stock and it was almost impossible to manipulate the stock price (down) of the best investments.

Let me explain this in plain English.

When you “short” a stock, you are betting that the price of the stock is going down.  So you borrow shares from a broker and then sell the stock you don’t own (that’s what shorting a stock is) at a high price.  If everything goes as planned, the stock drops in price and you buy it back.  Then you return the shares you borrowed.  Everybody’s happy.  Some people even think of this as one of many small business ideas.

Again, if you sell a stock short when the price is declining, you are adding to downward pressure big time.  Especially if you are a hedge fund and sell lots of shares short.

Can you guess why the SEC put this uptick rule in place in 1934?  If you said it had something to do with the stock market crash of 1929, you are right.  The SEC put this rule in place to stop speculators from pouring fuel on the fire so to speak.  And the crazy thing about it is, it worked.  It worked for a very long time.

For decades and decades the market was fairly orderly.

But look what happened to volatility as soon as they suspended the rule in July of 2007:

(This is a graph of VIX – it’s a proxy for market volatility)

Do you see the volatility spike up?  And can you see what happened to the stock market at almost the exact same time?  It started its meltdown — that’s what happened.

I’m not saying that the suspension of the uptick rule is responsible for all the problems in the market.  But it certainly has made a bad situation worse.

A friendly Wealth Pilgrim in Arizona sent me a news item that said that the Congress is considering reinstating the rule and that would be a wonderful thing.   It would probably help stabilize the market.  It sure couldn’t hurt.

What can you do?  Glad you asked.

Please call your Representative today and tell them how important it is to have the uptick rule reinstated.

Oh, and while you’re on the phone, tell them we’re watching them now so they better get it together!