Lessons From Crash and Resurrection
4. The Uptick Rule: You can bet the stock of a company will go down by selling short--that's sell that stock even though you don't own it. If the price does go down, you then buy it at the new lower price and make money. Conversely, if you guess wrong and the stock goes up, you have to buy it at the new higher price and you lose. The Securities and Exchange Act of 1938 decreed that a trader can only sell short on an uptick--an increase in price on the last transaction. Otherwise bear traders could short, short, short with impunity and drive prices down. On July 6, 2007, the SEC commissioners voted to repeal the uptick rule.
5. Naked Short Selling: If you sell short--selling stocks you don't own--theoretically you're required to locate the number of stocks you want to sell and "borrow" them. Selling stocks you don't own without borrowing is called naked short selling--frowned on by the SEC but heretofore not enforced. "What I do know is that many fellow traders, who, like me, prefer to trade short, are raking in the profits," wrote equinetrader.blogspot on Aug. 15, 2007. "The past few days have been a dartboard in the market. Shoot and short. The goal this past week has been to find any kind of upward momentum in the market--then short it, and keep shorting it. Short Apple, short RIM, short financials, short Nike for heavens sake. Just short it." New York Attorney General Andrew Cuomo said that short sellers "are like looters after a hurricane."
These five elements created a perfect financial storm that came close to destroying America and the world economy.
Finally, this past Friday, the SEC banned short selling for 799 financial company stocks--a case of locking the barn door after the horses were stolen.