What is an Uptick?

When trading of a financial instrument occurs at a higher price than the preceding round, it is known as uptick or plus tick. It is an increase in the market price of a financial instrument over the previous transaction. Even if the market price increases only one cent then also it is considered to be on an uptick. The concept of the uptick is important when it is connected to short-selling stocks. Uptick rule prevents short sellers from putting unfair pressure on a stock's price.

How Does an Uptick Work?

According to Uptick rule, short selling a stock is only allowed on an uptick. That means short selling can only be done at a higher price than the last traded price of the stock or at the last traded price when the most recent price movement was upward. The uptick rule was adopted by the United States Securities and Exchange Commission in 1938 to prevent market volatility. It was known as rule 10a-1. The rule was in effect till the introduction of Rule 201 Regulation SHO in 2007. According to the rule, since 2001 the minimum tick size for the stocks that are trading above $1 is 1 cent. If the trading price of stock raises from $11 to $11.01, then it is on an uptick. The short sellers, like any other investors, try to buy the stocks at a lower price and sell it at an increased price. However, they try to do it in reverse order. First, they sell at a higher price and then they buy it in low. In this way, they capitalize on an anticipated decline in the price of a stock. If a large number of investors short or sell a particular stock, their collective action can have a dramatic impact on the market price of that share. Without the uptick rule in place, the traders can engage themselves in short selling to drive down the price of a stock for creating panic among the shareholders. The panicked shareholders would then sell their stocks to avoid further damage. This technique of manipulating the market is called "bear raid" and it is considered illegal. The uptick rule attempts to discourage this by allowing a short sale only when the stock is trading up. So that the investors have less incentive to conduct bear raids. In 2004, the Securities and Exchange Commission removed the uptick restriction from about a third of listed stock to understand if the uptick rule is at all effective in preventing bear raid. After a yearlong test, they decided that the uptick rule seems to be ineffective in preventing market manipulation, rather it modestly reduces liquidity. This, the rule was eliminated altogether in July 2007. However, the decision of lifting the uptick rule was criticized by some eminent market experts and after the outbreak of 2008 financial crisis, some of them stated that the crisis was triggered by the elimination of uptick rule. The New England Complex Systems Institute presented a paper that claims to have found evidence supporting the above statement. They said a Bear Raid market manipulation by short sellers against Citigroup in November 2007 actually triggered the crisis. In 2009, the Securities and Exchange Commission considered reintroducing the uptick rule and voted to seek public comment on this. It prepared a proposal containing 273 pages and released it in public on April 17, 2009. The comment period was open until June 19, 2009. The proposal published by the SEC states, "We are proposing two approaches to restrictions on short selling one is a price test that would apply on a market-wide and permanent basis ("short sale price test" or "short sale price test restriction") and one that would apply only to a particular security during severe market declines in that security ("circuit breaker"). With respect to the first approach, we propose two alternative short sale price tests: one based on the national best bid and the second based on the last sale price. With respect to the second approach, we propose two basic alternatives: one alternative is a circuit breaker rule that would temporarily prohibit short selling in a particular security when there is a severe decline in the price of that security (a "halt"), which could operate in place of, or in addition to, a short sale price test rule; and the second alternative is a circuit breaker rule that would trigger a short sale price test rule; we propose that such a short sale price test either be based on the national best bid for any security for which there has been a severe price decline or be based on the last sale price for any security for which there has been a severe price decline." After this exercise, an alternative uptick rule was adopted by the SEC. Rules 200(g) and 201 of Regulation SHO [17 CFR 242.200(g) and 17 CFR 242.201] under the Exchange Act was amended to introduce the alternative uptick rule. The new rule is applied only when a stock's price falls 10% or more from the preceding day's closing price and remains effective until the closing of the next day.