A short sale restriction, also known as the short sale rule or alternative uptick rule was enacted in 2010 under SEC rule 201. The short sale rule restricts the shorting of a stock that has declined 10% or more in one trading day. Once the rule is enacted on a security the stock cannot be shorted unless it is moving upwards, making it very difficult to short. The rule applies to all exchange traded and OTC equity securities.
As a day trader, it’s important to understand the SSR rule and how it can affect your trades. Additionally, for seasoned traders experienced with short selling there are various trading strategies built off of short sale restrictions.
This guide will cover the history of the alternative uptick (SSR) rule, provide an example of how it works, and discuss high level short sale restriction trading strategies.
The 1938 Short Sale Rule
The original short sale rule was in effect from 1938 until 2007. It was passed to prevent the short selling during a declining market. However, when it was initially enacted there was no electronic trading. Everything was done physically on the floor of the exchange. This allowed for easy market manipulation.
Traders would team up and short sell stocks together to create market panic and drive prices down. Ultimately, they would manipulate the market and cause panic from which their short sales profited off of.
To combat this manipulation, the original uptick rule was established. If you wanted to enter a short-sale position it had to be executed at a price higher than the previous trade. Therefore, you could only enter a short sale while the stock price was increasing, or on an uptick.
The rule was repealed and dismissed in 2007. By this time the exchanges had shifted to decimal trading and everything was done electronically. Therefore, it was determined this rule was obsolete and no longer needed.
2010 Alternative Uptick Rule
The short sale rule in effect today was enacted in 2010 and is commonly referred to as the alternative uptick rule. While the financial crisis and stock market crash that occurred in 2008 was surely caused by a market bubble, short selling manipulation exacerbated the market decline.
Therefore, in 2010 a new short sale rule was reintroduced. The rule prevents short selling of a stock unless it occurs on a price uptick, once a stock has fallen 10% or more in one trading day. The rule is meant to benefit long position holders and given them an opportunity to exit before short sellers enter the mix.
To purchase a stock with a short sale restriction on it the stocks price has to be above the current bid. This rule is made to prevent flash crashes and to minimize downside volatility.
Short Sale Restriction Rules
- It is enacted when a stock takes a 10% decrease over yesterdays closing price
- The restriction remains for the rest of the day trading, and potentially into the next trading day, even if the stock price rebounds
- It covers all equity securities including ones traded over the counter and on exchanges
- All brokerages, exchanges, trading centers, etc. must have policies and procedures in place to prevent a short sale during an SSR
Stock Short Sale Restriction Example
Let’s say we have a stock that opens at $5 and runs all the way to a $10 close. The next day, short-interest might be really high and a lot of winners are closing out their positions. This causes the stock to open at $9, which is a 10% decline over yesterdays close. This would cause a short sale restriction to be placed on this stock.
Now let’s say that the stock rallies intraday up to $11 and you decide you want to short it if it falls back below $10.50. You wouldn’t be able to do this unless the stock first falls below $10.50 and then upticks back up to $10.50. You could short it at $11.01 but you can short it at a price below the current bid.
Can you Short a Stock with SSR?
Yes, you can short sell a stock that has a restriction on it. It just makes it a bit more difficult to short and a bit more risky. To short a stock with a short sale restriction, you have to short it while the price is moving upwards. This prevents the ability to ride the downward wave and put further downward pressure on the stock price via short sale. It is more risky because a short sale restriction usually results in more buyers than sellers in the market which causes upwards price pressure and can cause big short squeezes.
SSR Short Selling Strategies
Short sale restrictions are most common amongst small cap stocks with low floats. Large stocks just have too many outstanding shares and traders to make drastic movements either upwards or downwards. On the other hand, smaller stock with low floats can easily make aggressive moves which creates trading opportunities.
When you get a stock with a short sale restriction, it creates a discrepancy between the number of buyers and sellers. Since it is more difficult to short sell it means you usually have more buyers than you do sellers. This can cause big short squeezes, where short sellers who got in before the SSR are getting hammered and need to close their position to minimize further losses. This further drives pricing upwards.
Most SSR’s are triggered by pre-market gap downs. Most stocks that gap down pre-market will continue to slowly decline, have big pops from shorts covering, and then continue to drop.
Going long on SSR Stocks
Option A for trading an SSR stock is to go long on it. Most SSR stocks start by gapping down in the pre-market. Existing short sellers will take profits causing prices to drive back upwards. The price going back upwards also provides the opportunity for short sellers to open new positions which can then flip the stock back downwards. This is why you will see a lot of SSR stocks popping frequently and then fading. However, it can also cause big squeezes and multi-day runs as short sellers are more hesitant to enter on an SSR given the difficulty and limited number of other short sellers entering the market.
These pops provide the opportunity to go long and profit from short squeezes. There are a lot of SSR restricted stocks that go on long multi-day runs due to the imbalance between buyers and sellers and the difficulty for shorts to enter positions.
Shorting SSR Stocks
Since the naturally tendency for a short sale restricted stock is for it to slowly bleed downwards, there is opportunity to short the stock while it is going upwards. The risk is shorting a stock at the wrong time and then it continuing to run which then gets further squeezed upwards. Therefore, shorting SSR stocks is only recommended for advanced short sellers.
The idea here is to short the stock as it reaches the top of an uptick and then to cover once it fades back down. Since you can only purchase on an uptick, entry is everything. You don’t want to buy a stock at the very start of its uptick, but rather purchase it at the top of the uptick. Bear flag consolidations are a common entry signal for SSR shorting.