Every watcher of this week's stock market had stomached an unusual number of ups and downs. Little did people know that a recent chage of an important trading rule for short sellers may be a crucial factor behind the increased market volatility.
In an USA Today story, Emily Chasan explained that the Securities and Exchange Commission changed the rule in early July without too much public attention:
"Short sellers bet a stock is overvalued and that its price is likely to fall. They borrow shares, sell them and then wait for the stock to fall so they can repurchase the shares at a lower price, return them to the lender, and pocket the difference.
But until last month, short sellers were only allowed to sell at a price above the last price of a stock, or at the price of the stock's last trade if it was higher than the previous price.
The so-called "uptick rule" or "tick test" was implemented in the 1930s after the stock market crash to ensure short sellers were not alone in causing a stock price to fall.
But regulators at the Securities and Exchange Commission revoked the rule in July, suggesting it modestly hurt liquidity and did not appear necessary to prevent the manipulation of a stock price."
And on the impact:
But others worry now that the SEC has revoked the rule at a time of tremendous uncertainty, short sellers are closing in.
"The hedge funds were very, very aware of this. They sit around and giggle when this stuff happens," said Mallory Hill, chief executive of mortgage lender Novelle Financial Services. "Without the uptick rule, they can put anyone out of business."
For ordinary investors, is it time to explore the territory of short selling? Probably not. WSJ's columnist Jonathan Clements is claiming that the valuation of the S&P 500 is "on cheap side". For me, my portfolio suffered my fair share of market turmoil with a heavy concentration on financial stocks, but again, I'm looking for opportunities to redeloy my six-figure cash positions and build more stocks on the cheap.