Understanding the Uptick Rule

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Uptick Rule

was originally created by the Securities and Exchange Commission (SEC) in 1938 to prevent short sellers from conducting bear raids on companies whose stock prices were falling lower and lower and lower. Sixty-nine years later, at the end of 2007, the SEC dropped the uptick rule. However, there are rumblings on Wall Street and in Washington that the uptick rule might be brought back.

[VIDEO] Understanding the Uptick Rule

What is the Uptick Rule?

The uptick rule states that you cannot sell a stock short on a down tick. You must wait until the price of the stock you are looking to sell short has an uptick before you can enter your trade.

In theory, this rule is supposed to reduce dramatic bear runs on stocks that are fueled by short sellers. After all, if stocks that are going down never tick back up, short sellers won’t have an opportunity to jump into the game by selling more shares short.

Bringing the Uptick Rule Back

During the financial sector meltdown on Wall Street in 2008, the SEC temporarily banned short selling on financial stocks like Citigroup (C), JPMorgan Chase (JPM) and Wells Fargo (WFC) in an attempt to help stabilize their stock prices.

This measure seemed to slow the decent of these stocks, but in the long run, many financial stocks continued to drop to just above penny status.

Even so, in a recent testimony before the House Financial Services, Fed Chairman Ben Bernanke said reinstating the uptick rule across all stocks, not just financial stocks, “might have had some benefit” on stock values during the market collapse.

If the SEC does, in fact, reinstate the uptick rule, watch for stock prices to stabilize somewhat in the short term. The long term, on the other hand, is a different story.