On July 6th, 2007 the SEC did away with the 'uptick rule'.
The WSJ's Heard on the Street column covered this on 8/14/07: "The old rule generally prohibited the shorting of a stock while its price was falling, or experiencing a "downtick" in trader slang. The rule was instituted after the 1929 market crash in order to discourage avalanches of short sales to push a particular stock -- or even the broader market -- precipitously lower." ... "At the New York Stock Exchange, traders pointed to the downtick rule on July 26, when the Dow Jones Industrial Average sank 311.50 points, or 2.3%, to finish at 13473.57. " ... "Seaport Securities broker Theodore Weisberg agrees: 'They quietly changed the ground rules,' says Mr. Weisberg. 'There's no question it's been an aphrodisiac for volatility.' "
There's been some discussion about how 'bad' this could be for orderly markets. Some traders think it will help speed 'price discovery'. Others are leery of increased volatility.
Three other items may also increase volatility:
(1) Rapid growth of ETFs. ETFs have been short-able on downticks for some time. So one trade is like shorting 50, 100, 500, or 3000 stocks at a time, depending on the ETF.
(2) Reg NMS, a rule which requires trades to be routed to the exchange with the best price, came into effect earlier this year. One effect is that large blocks are being broken up and done here and there. Good for the retail crowd. Not so good for institutions with large blocks to trade. One trader told me that Reg NMS rule "shrinks average print size" and "ETFs, algorithm trading, uptick reversal and Reg NMS certainly have made execution challenging to say the least."
(3) The NYSE hybrid model has led to reduced influence of the specialists. Some are pleased they no longer have a monopoly on their stocks but the orderliness they added to the markets is gone so volatility is up. Just look at how empty the NYSE floor is on CNBC. When they sing the annual Christmas song this year, I think they're going to have to drag guys in off the street to have crowd.
My take on all of this is that downside volatility in US equities has taken a step up and some US equity trading systems will require wider stops to stay in trades.
I.e., systems developed on pre-2007 volatility levels may get stopped out more than expected.
Also, rules like 9-1 up days and down days in the market, which used to be rare and good signals of market bottoms, are likely to become more common and less reliable.
Discussions about Money Management and Risk Control.
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