June 1, 2009
As a former specialist on the NYSE floor, I know the value added that short sellers provide to the the capital markets. They are a vital component in the US financial markets. The manner in which they execute their strategies needs to be explored.
During the Reg SHO pilot conducted by the SEC, we were in the latter stages of a multi-decade bull market. Based on empirical financial theory, approximately 50-60% of an individual stock movement is based on the overall market. About 25% is based on the industry price movement with only 10-15% based on individual company developments. As a result, the pilot was like a boat going against a tidal wave. It was not surprising that the SEC adopted the new rule. The rigor of their test was lacking. There was no recognition of the interdependence of markets between the individual stock, ETFs, options, individual stock options/futures, credit default swaps and other derivative products. In fact during this test period, I spoke to a few companies and said that they should address the potential repeal of the plus tick rule. I noted that it was like a drug that they had been taking for about 70 years and were about to stop taking. The companies would not realize the benefit of the rule until they stopped taking the drug(plus tick) Well, within a few years they found out.
As you explore the reinstatement of the plus tick rule, be aware that all parties have a self interest(read profit) incentive other than the individual investor. As a trader and from a selfish standpoint, I would prefer the current status quo. However, the manipulation that hedge funds and large investors can reek on the financial markets thru these interrelated markets has the potential to take down the whole system. That is what early March, 2009 felt like to me. The only other time was as a new specialist in 1987 when my father told me on the night of October 19, 1987, that he might lose everything the next day. That was due to the portfolio insurance virtuous cycle similar to the current cycle of put buying,naked shorting, buying credit default swaps and the use of the media. The plus tick rule would help to slow up the process
The exchanges will fight this reinstatement because they are profit machines. They will have to spend money to re program their systems. Their main source of profit is from transactions. This rule may limit the high frequency trader. In addition, it may impair the profitability of certain ETFs, such as the 2x. Their model is based on the more volume the better. The thought that the programming would be too onerous is balderdash The US financial system is more important than their profitability.
Why not try a pilot for a year to test the plus tick rule
In addition, ENFORCE your rules. No naked short-selling.