Is the Repeal of the Short Sale Tick Test Rule Behind This Market Volatility?

dropping dollar signI was reading through the Wall Street Journal this morning, and an article caught my eye that made me laugh. I just knew that this was coming, but I didn't expect some traders to grumble about it so quickly.

Some traders are blaming the recent market woes on the fact that the short sale tick test rule has been repealed (it was repealed in July after two years of debate by the SEC.) Previously, you couldn't short a stock on a "downtick." This was instituted after the 1929 crash to prevent people from piling on a stock using short sales and driving it into the ground. Basically, the way that the previous rule was written, you needed to wait for the stock to rise before initiating a short position. That would mean, if you really wanted to get into a stock on the short side, you would have to wait for an uptick, which is pretty laughable when you think about it. There is nothing wrong with jamming a stock on the long side and piling in and driving it to the moon, but if you want to short, you need to follow this "tick test" rule. It was absurd and I am glad that the SEC did away with it.
The SEC did away with the rule, and now we get an article in the WSJ about a month later, interviewing traders that are grumbling about the rule. Without a doubt, this rule adds to short-term volatility in a stock, but I stress, short-term volatility. To blame the repeal of this rule for the recent stock market woes is absurd. How about blaming the meltdown in subprime mortgages? Quant fund blow-ups? High oil prices?

Some traders point to the VIX being a lot higher since the rule change was implemented (VIX measures volatility in the market.) I would point to the fact that the subprime mortgage meltdown began right around that time as well. In this day and age, with such sophisticated tools and traders, the elimination of the short sale tick test rule might increase short-term volatility in a stock, but to blame it for the recent stock market woes when there are such other glaring culprits is just silly.

Filed under: General Market News | Stock Market Education

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