The Uptick Rule Makes Buying More Tricky

I have seen a lot of press lately that the uptick rule will be brought back. In short, Wikipedia defines the uptick rule as follows:

The rule limits the timing of short sales. It mandates, subject to certain exceptions, that, when sold, a listed security must either be sold short at a price above the price at which the immediately preceding sale was effected or at the last sale price if it is higher than the last different price.

The key here is that the uptick rule can limit the timing of short sales, but not short sales themselves. I have not seen any in-depth analysis of what effect the up-tick rule has on the price discovery process if any. But lets take a look what it could potentially mean.

As a market participant you have basically two choices when you place an order. You can place your order at the best offer (BO) price or higher, or you can place it at the best bid (BB) or lower. If you place it at BB or lower, you should get filled almost immediately. If you place it at BO or higher, you will have to wait until someone else places a bid your price.

Now, with the uptick rule in place, if you place your offer at BB or lower, and the last trade was at a price higher than BB, the exchange will not execute your order. I'm not sure what they would do with it, I imagine that they will either reject it or defer it until the price ticks up. It is quite possible, that because the exchange will wait for an up-tick, you will be able to sell at a price that is one tick better. Does your action of selling at slightly better price have smaller negative impact on the market? No, I don't think so. It doesn't matter how you sell, as long as you can sell you will have some negative impact on the price.

The uptick rule creates a share of problems for the buyers as well. If you are interested in buying at a given price, you want to know that there are enough people interested in selling to you. However, if you happen to want to buy at a price that is not an uptick, the short sellers will not be able to sell you to. You may then have to wait for an uptick and buy at a higher (worse) price.

It is not true that the uptick rule prevents bear market or stock market crashes. The uptick rule has been in place during the recessions of '74, '81 and 2001 and the crash in '87. To suggest that without the uptick rule any of those episodes would have resulted in smaller market declines is absurd. If anything the opposite is true.