SEC To End the Short Sale Tick Test Rule

Short-sellers everywhere are rejoicing tonight.

The SEC has announced that effective July 6th, 2007, traders will be able to short any security on an up, down or zero tick. Previously, the rule had been that you had to have an advancing market in a stock in order to get in a short sale. Meaning that if the stock was falling and the last trade was a downtick, you would be unable to short.

The tick test was first implemented in the 1930's after the big stock market crash. Back in those days, there was no surveillance and regulation of the markets, and a lot less transparency, so a tick test rule would have made more sense. Nowadays, the markets are much more liquid, transparent and well-regulated, making the need for a tick test largely irrelevant.

The thought process of those in favor of the tick test rule was that short-sellers could seek to target a stock for a "bear attack" if the tick test rule wasn't in place. Meaning, a group of traders could join together to short share after share of a stock, driving the stock lower.

In this day and age though, such occurrences are extremely rare, due to the well-policed nature of the stock market. I am not talking about the SEC policing the stock markets, I am talking about average investors policing the stock markets. There is so much important and all data is available real-time to investors now; if a bear attack did take place, word would get out and value investors and current longs in the stock would buy up the shares, negating the value of a bear attack. There is just too much liquidity in the markets now to really justify having the tick test rule.

There is a saying that applies to the market. "Water always seeks its own level." People shouldn't be worried about the downside volatility that could be created by eliminating the tick test rule, as inevitably, the stock market will find the correct value for a stock. If a good stock gets unfairly punished by short-sellers, it will bounce back to its earned price level, I can guarantee you that.

All in all, a good move by the SEC to eliminate a rule that didn't have any relevancy in today's stock market. There will be many people crying foul, but in my opinion, they don't really understand the dynamics of the stock market.

Filed under: General Market News

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