What Is the Uptick Rule?

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DEFINITION
The uptick rule is a regulation requiring any short sale to take place at a higher price than the stock’s last trading price if that stock is down 10% or more from the last trading day’s closing price. It was put in place by the Securities and Exchange Commission (SEC) in 2010.

The uptick rule requires any short sale to take place at a higher price than the stock’s last trading price if that stock is down 10% or more from the last trading day’s closing price. It was put in place by the Securities and Exchange Commission (SEC) in 2010.

Learn more about the uptick rule and how it’s designed to stabilize the market and protect long-term investors from short-sellers who may try to artificially drive the stock price down. 

Definition and Examples of the Uptick Rule

The most recent version of the uptick rule was established by the SEC in 2010 to prevent price manipulation by short sellers attempting to force down the price of a specific company’s shares in order to prompt additional sales by panicking shareholders in what is called “a bear raid.” The rule is designed to ensure market stability and create investor confidence.

  • Alternate name: Alternative uptick rule

The uptick rule applies to short sales, which are stock trades where an investor is betting that the price of the stock will fall. The rule is designed to prevent a rush of short sales from artificially driving down the price of the targeted stock so that short sellers can unfairly earn profits. The uptick rule does this by requiring that any short sale must take place at a higher price than the last trade if that stock is trading at a price that’s down 10% or more from the previous trading day’s closing price.

For example, let’s say shares of Company XYZ are trading at $9 after closing at $10 the previous trading day. The $9 price is 10% lower than the previous trading day’s closing price of $10, so this triggers the uptick rule, which means no short sale can take place unless the share price trades at $9.01 or more.

How Does the Uptick Rule Work? 

By limiting short sales, the uptick rule is designed to stabilize the market, prevent price manipulation, and promote investor confidence by protecting long-term holders of shares that could be targeted by short sellers looking to drive the price down for a quick profit. By requiring that any sale take place at a higher price when a stock is down 10% for the day, the uptick rule cuts off additional short sales that could trigger panic-selling and force losses on long-term investors in the stock.

By requiring a 10% decline before taking effect, the uptick rule allows a certain limited level of legitimate short selling, which can promote liquidity and price efficiency in stocks. At the same time, it still limits short sales that could be manipulative and increase market volatility.

The uptick rule originally was adopted by the SEC in 1934 after the stock market crash of 1929 to 1932 that triggered the Great Depression. At that time, the rule banned any short sale of a stock unless the price was higher than the last trade. After some limited tests, the rule was briefly repealed in 2007 just before stocks plummeted during the Great Recession in 2008. In 2010, the SEC instituted the revised version that requires a 10% decline in the stock’s price before the new alternative uptick rule takes effect.

The rule is designed as a market circuit breaker that, once triggered, applies for the rest of that trading day and the following day.

Pros and Cons of the Uptick Rule

Pros
  • Prevents stock manipulation

  • Protects investors with long positions

  • Promotes market stability and investor confidence

  • Allows room for legitimate short selling


Cons
  • Rule may not have any effect on volatility

  • Limiting short selling may protect overvalued shares


Pros Explained

  • Prevents stock manipulation: The uptick rule aims to prevent price manipulation by short sellers attempting to force down the price of a specific company’s shares for their own profit.
  • Protects investors with long positions: By requiring that any sale take place at a higher price when a stock is down 10% for the day, the uptick rule cuts off additional short sales that could trigger panic-selling and force losses for investors with a long position in the stock
  • Promotes market stability and investor confidence: The rule is designed to prevent price manipulation; avoid large, sudden changes in share prices; and promote investor confidence by protecting long-term investors (such as those investing for future retirement).
  • Allows room for legitimate short selling: By allowing a limited level of legitimate short selling, the rule can promote liquidity and price efficiency in stocks, while limiting manipulative short sales.

Cons Explained

  • Rule may not have any effect on volatility: A 2005 SEC pilot study of 943 stocks found that the uptick rule had no significant effect on market behavior. The SEC could conduct a study like this again to see how the uptick rule impacts the market today.
  • Limiting short selling may protect overvalued shares: Many investors consider short selling a way to expose overvalued shares and establish a more appropriate price. Limiting the practice of short selling could dull its effectiveness.

What It Means for Investors

Some opponents of the rule say that modern split-second digital trading, program trading, and fractional share prices make the uptick rule outdated and that it unnecessarily complicates trading. While they may not be for the rule it is still in place as of 2022 and investors should keep it in mind if they’re ever planning to short sell a stock. Though also remember that short-selling comes with a lot of risk. Make sure you understand this investment strategy before executing it. If you have a long-term investment strategy, such as investing for retirement, consider simply sticking to your plan. If you ever need help, consult an investment or financial advisor.

Key Takeaways

  • The uptick rule is designed to limit aggressive short-selling and to prevent stock manipulation and volatility.
  • The rule may also help protect long-term investors from abusive short-selling.
  • The rule requires any short sale to take place at a higher price than the last trade if that stock is trading at a price that’s down 10% or more from the previous trading day’s closing price.
  • Some research indicates the uptick rule may not have as much influence on volatility as was once thought. It’s also believed that the rule may allow overvalued shares to go undetected.

Article Sources

  1. U.S. Securities and Exchange Commission. “Nibbling at the Edges—Regulation of Short Stock Borrowing and Restoration of an Uptick Rule.” Accessed Jan. 20, 2022.

  2. U.S. Securities and Exchange Commission. “SEC Approves Short Selling Restrictions.” Accessed Jan. 20, 2022.

  3. U.S. Securities and Exchange Commission. “Short Sale Restrictions.” Accessed Jan. 20, 2022.

  4. New England Complex Systems Institute. “Regulation of Short Selling: The Uptick Rule and Market Stability.” Accessed Jan. 20, 2022.

  5. GovInfo.gov. “Federal Register: Part II Securities and Exchange Commission Amendments to Regulation SHO; Final Rule.” Accessed Jan. 20, 2022.

  6. Fidelity. “How To Short Stocks.” Accessed Jan. 20, 2022.

  7. Tuck School of Business at Dartmouth. “The Uptick Rule and a Long View of Short Selling.” Accessed Jan. 20, 2022.