What Is the Uptick Rule?
Let me explain the Uptick Rule directly to you—it's also called the 'plus tick rule,' and it's a regulation from the Securities and Exchange Commission (SEC) that demands short sales happen at a price higher than the last trade.
You might engage in short sales if you think a security's price is about to drop; the strategy is to sell high and buy low later. Short selling can boost market liquidity and help with accurate pricing, but it can also be misused to push a security's price down further or speed up a broader market fall.
Key Takeaways
- The SEC's Uptick Rule requires short sales to be conducted at a higher price than the previous trade.
- There are limited exemptions to the rule.
- A revised rule implemented in 2010 lets investors exit long positions before short selling is triggered.
Understanding the Uptick Rule
The Uptick Rule stops sellers from adding to the downward pressure on a security's price when it's already dropping sharply. When you place a short-sale order above the current bid, you're making sure it's filled on an uptick.
This rule started with the Securities Exchange Act of 1934 as Rule 10a-1, and it went into effect in 1938. The SEC got rid of the original in 2007 but brought in an alternative in 2010. Now, trading centers must have procedures to block the execution or display of prohibited short sales.
The Alternative Uptick Rule
The 2010 alternative uptick rule, known as Rule 201, permits you to exit long positions before any short selling kicks in. It activates when a stock's price drops at least 10% in a single day. From there, short selling is allowed only if the price is above the current best bid. This setup is meant to keep investor confidence intact and ensure market stability in stressful, volatile times.
The rule's 'duration of price test restriction' keeps it in place for the rest of that trading day and the next one. It covers all equity securities on national exchanges, no matter if they're traded on the exchange or over the counter.
Remember, the Uptick Rule exists to maintain investor trust and steady the market during high-stress events, like a panic that causes prices to crash.
Exemptions to the Rule
For futures, you'll find limited exemptions from the uptick rule. These can be shorted even on a downtick since they're highly liquid with plenty of buyers ready for long positions, which keeps prices from being driven unjustifiably low.
To get this exemption, the futures contract has to be 'owned by the seller' per SEC terms—that means you hold a security futures contract to buy it, you've been notified it'll be physically settled, and you're committed to receiving the underlying security.
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