Reinstate The Uptick Rule

It is no secret that short selling is controversial, critics say it allows speculators to destroy businesses and provides incentives for the spreading of malicious rumors in order to drive the stock down.

On the flipside, supporters say price discovery is improved because negative views on the stock price can be expressed.

And this is how arguments for and against shorting basically run. However, the most convincing answer I've heard lies somewhere in between.

Shorting should be thought of as medication. Taken in the right quantities it aids recovery but overdosage is downright poisonous. What really kept shorting in the right quantities was the uptick rule. The rule mandates every short sale transaction be entered at a price that is higher than the price of the previous trade. In other words, the uptick rule prevents short sellers from adding to the downward momentum when the price of an asset is already experiencing sharp declines, there must be an uptick in the price before you can short.

This rule was of course eliminated by the SEC in July 6, 2007 because the uptick rule "modestly reduce[d] liquidity and do[es] not appear necessary to prevent manipulation." This is course the same SEC which has been asleep at the wheel for everything else.

Like most other other forms of deregulation the effects were debated and unknown in the immediate aftermath, but within 12 months, it became clear that market volatility had increased and the number of stocks declining by more than 40% in one day had doubled.

It amazes me that the SEC empowered by hindsight knowledge of the 1930's, which is always 20/20 vision I am told, could ever eliminate the uptick rule. The children have been allowed to play with matches and now the house is on fire. The uptick rule needs to be reinstated immediately, and if a few hedge funds grumble, please don't lose sight of the burning house.