May 4, 2009
Short sellers serve a vital function in the US marketplace however, priority ought to trump the ability of an individual to confuse other investors in times that the benefit of short-selling are outweighed by the cost to the marketplace. Short-sellers are decent people and just want to make an honest buck. Sometimes, people short-sell to hedge their risks, whereas other times, people short-sell to profit from over-priced stocks or companies that shouldn't exist (i.e. GM and Chrysler in their present form). Lastly short-sellers played a vital role in 2000 in alerting us of the tech bubble, of Enron, and of WorldCom they found the troubles long before the regulators did and that was very beneficial to individual investors. In 2000, the uptick rule helped maintain a stable market and didn't interfere with a short-seller's ability to make money on stocks. Anytime, the market falls 20% off the peak, the uptick rule should apply (until the peak is surpassed). Even if it is 2 years ago that you were 20% off the peak, the uptick rule should apply. I think we ought to have a 3 second uptick rule on downticks to prevent people from getting around the rule and it should range from $.01 to $.05. Any stocks on a watch-list, should have, in my opinion a $.25 uptick and these should involve thinly-traded stocks and bonds.
So what do I recommend for an uptick rule?
I feel that the best uptick rule either is a $.01 to $.25 uptick that applies for 3 seconds following a negative tick that a short-sale cannot take place. I do think that 2 modified versions could allow for a stable market:
1) The first option is to have short-sales be permitted only if the market closed up the previous day.
2) The second option is to require an uptick if the market has fallen by 20% or more within the preceding 12 months or better yet, until the market fully recovers from the 20% fall. I think the rule should be immediate once the market closes 20% lower the rule goes into effect immediately. That's my hope.
That's very different from the virulent short-selling we've had in 2008. It was perilous to investor's health. Without the uptick rule, individual investors (and even the smart money mutual funds) had no idea whether the selling was due to short-selling or people selling their investments it is essential that people know the difference and price-action should be from the underlying fundamentals (not from the momentum of short-selling). I think that's especially true when you look at margin the effectiveness of margin is incredibly bad whether on the long or the short side. It is not a good long-term investment because of the under-estimation of risk in most Corporate Finance classes. The most efficient level of margin is when an investor uses between 5-10% margin and by the time the investor hits 12.5% margin, the average historical return (going back 200 years) was equal to the return of a fully-invested investor with no margin. Anything beyond 50-75% margin led to negative returns (probably beginning at 62.5% margin). That said, I'm hoping you will take a look at lowering the margin rate allowed from 4:1 to 3:1 for day-traders and 2:1 to 1.25:1 for typical investors. Lastly, I think some traders accidentally do PDT and thus the rule should be modified to 10 trades in a 5 day period or two consecutive weeks of 4 trades in a 5 day period (to show a true pattern).
Back to the uptick rule, I really think a stable market is important. While the speculators were harmful to individual gas payers, they were decent human beings and that didn't result in a loss of jobs in the same way that short selling has. Also, there was a genuine short-supply of gasoline whereas companies like JCP with great balance sheets got hit hard by the lacking of an uptick rule.
I think the uptick rule need not apply in bull markets, but as long as the market is 20% away from the peak, the market needs some form of stability so investors can tell the difference between a seller (or to sell one's shares) and a short seller (or borrower of stock) it's important so someone can make a prudent decision.
Also, in the 1930s bear raids were common. Those in 1929 could have stated that the uptick rule is not necessary as the first 34 years were stable (assuming a modern market open in 1895). There was a crash in 1907, like this year, but to take the risk of another depression with 12-18% unemployment is too risky just so someone can have the opportunity to be a scavenger investor by betting on that company being overvalued or insolvent it is a set of priorities. I don't think firms with great balance sheets (like JCP) should fall 80% it is difficult for an investor to know whether their panic is justified or not and investors are likely to hit the exits at the same time they should be buying. If the uptick rule had been in effect, a stock like Macy's would have fallen 80-90% but JCPenney probably wouldn't have fallen as much (i.e. 60% to $30 per share). I personally owned JCPenney since I liked its balance sheet, sold it at $30 and rebought it at $21. It is only 0.5% of my portfolio as I am a true proponent of index funds, but usually devote 10-15% towards being like Buffet and my 18% loss since the peak has made me feel good.
I know financial advisors who mistakenly use the double-long and double-short ETFs as part of their client's portfolios. Unfortunately, these products are not suitable for anyone. The reason is because they use an inefficient level of margin. The peak efficiency in margin is around 5-10% and returns start to become negative after you exceed 50-75% margin. Once you have 12.5% margin, you begin to have less of a return than you would with 100% stocks, particularly in volatile markets. Sometimes, the products work because if the market drops 50%, the product goes down 75%, but the upswing often doesn't increase 300% to get you back to even. The problem is these products lack consistency, should contain a maximum window time (i.e. 5 days to 6 months), and people need to understand the risks of investing in these products, including the potential to not obtain returns that are in excess of the market even if the product picks the right strategy this is vital to protect investors. Long-term investors best benefit by choosing index funds and by tracking the Fed Funds rate.
I hope this helps thanks for giving me the opportunity to comment on such an important issue. I am interested in helping people budget their money, save for their futures, and not over-pay for investment advice. I am interested in a role in compliance to assist investors with not getting taken by either unsuitable recommendations or improper investments.
Good luck to Obama this term. I am hoping that he can help us get out of this mess, this recession. I think he's doing all he needs to in order to help us get out of this bad economy.