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Uptick Rule Not To Blame For Volatility

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Adapt to markets changes, don't complain about them.

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We've been bandying the plus tick rule (or 'uptick rule') on my site a bit, and I received this thought-provoking comment from "Phil".

The uptick rule was simply designed to stop panic selling. The rule is, very simply, that you can only short a trade when the last trade is priced higher than the previous one (hence, the UPtick).

We already accept days where the market goes up 200 then down 200 in the same session, and volatility is through the roof since the July 6th removal of the rule.

I don't agree with the sentiment that "it's a tough market - deal with it." It's the Securities and Exchange Commission's (SEC) job (or it used to be) to protect the small investor.

Removing this rule was a mistake, the SEC should put it back and we can deal with that.


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Phil makes some good points, and his observations seem very real. The market and individual stocks are seeing volatility as high as any time in the past five years. Some traders are clearly going to thrive in that environment, others will get shelled.

Where I differ is in cause and effect. And what to do about it.

Volatiility trends are cyclical and long-lasting. Bill at VIX and More suggest they last 2-4 years. February 2007 was around five years into a downtrend measure from the highs in 2002. It also measured three and a half years from the end of the "up" era of volatility after the collapsing of the tech bubble. I suggest the pendulum was ready to swing north in volatility anyway.

It's important to note that generally uptrending volatility began in February of last year, four months before the plus tick rule ended. The collapse of the credit markets impacted volatility much more than anything else.

Furthemore, we're talking about market. Traders can short the market on minus ticks forever in the form of futures. Betting short has become exponentially easier over the years with minis, exchange traded funds (ETFs) and now inverse ETF's.

Trading rules and conditions change constantly. The switch from 1/8th's to 1/16th's and then to pennies arguably did more to enable shorting than anything else. Combine that with electronic communications networks, or ECN's, taking a bigger and bigger slice of the volume and you have trouble even defining a plus tick. By the time the SEC actually got around to changing the rule last July, it was a complete anachronism.

On an individual basis, I can sympathize with changes in the marketplace effecting trading models. I was an AMEX market maker from 1988-2001 and would love to go back in time a decade before automation, decimals and multiple listings. Spreads were wide and we effectively controlled them. But it's not happening. And the plus tick rule is probably not coming back either.

So I would summarize in a few points. Changes in the marketplace have happened all through time, this is just another one. It's not as cosmic as it seems. But whatever you think of the rule, the best response is to learn to adapt instead of looking for blame for a rough trading patch.

No positions in stocks mentioned.
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