Move on folks, no manipulation here.From Equedia:
The Removal of the Uptick Rule
Back in October 2012, a wide number of so-called trading enhancements were implemented by the TMX Group, home to Canada’s two largest exchanges, the TSX and the TSX Venture.
From my Letter, Why the TSX Venture is Failing:
“On October 4, 2012, the TMX Group sent notice to confirm “trading enhancements,” set to begin on October 15, 2012.
The enhancements in the notice reflected recent regulatory amendments respecting short sale regulation, the introduction of a short marking exempt designation, amendments respecting dark liquidity on Canadian equity marketplaces, and functionality introduced as a result of client demand and market quality initiatives.
When you try to fight one problem with another problem, the result is never positive. I will explain what’s happened in a bit.
But first, look at the one-year chart for the TSX Venture Composite since the rules were announced:
It doesn’t take a rocket scientist to break down the above chart.
Since the notice of the “Trading Enhancements Update” by the TMX, the TSX Venture has dropped like a rock.
Why?
The Death Spiral
When regulators forced the TMX Group to allow trading through alternative trading systems operated by third parties, it caused real-time transparency issues.
When you combine the lack of transparency in parallel trading platforms with the use of High-Frequency Trading (discussed last week), regulators had no choice but to eliminate the tick test rule, or uptick rule, for short selling.
Let me explain.
Discontinuing Price Restrictions of Short Sell Orders (Tick Test)
Historically, you could only sell a stock short if the price is higher than the last different price; simply put, you can only short a stock as it was moving up.
(This was know as the Uptick Rule.)
However, this rule only works when there is a strict sequence of orders in the order execution book; when bid/ask orders are placed in line on a first-come, first-served basis.
But with parallel trading systems, a definitive sequence of different prices can’t be established at any exact given point in time because one order book might show a downtick, while the other an uptick.
As a result, it would be extremely difficult to enforce the uptick rule.
By allowing competing trading platforms and encouraging HFT (which was believed to create more liquidity), regulators had no choice but to remove the tick test rule.
In the October 4th announcement, the rule was eliminated:
“TSX, TSX Venture Exchange (TSXV) and TMX Select will no longer constrain short sell orders to the last sale price. Short sell orders entered will be permitted to trade down to their limit price establishing a last sale price on a downtick. Short Crosses will no longer be constrained by the last sale price.”
This means we can now short a stock anytime we want.
That’s great news for short sellers, but for companies trying to raise money at higher prices to hire more staff or move their projects forward, this rule change can cripple them – especially under the liquidity constraints of the Canadian market.
It doesn’t take a lot of money to control a stock via short selling on the TSX Venture.
As a matter of fact, institutions often hammer stocks via short selling and back up their shorts with warrants they obtained in a previous financing. They often force the price of a stock down to finance the same companies they’re shorting to get a better financing price, or to force a company into a financing arrangement.”
The removal of the uptick rule has created a breeding ground for short funds to make a lot of money betting against companies – especially companies that trade on the TSX Venture.
When you consider that companies that trade on the TSX Venture are likely companies that are speculative and often negative cash-flow businesses, short selling can immediately hurt a company’s ability to finance.
Furthermore, short funds can use computer trading to add additional pressure on stocks to the downside by making it look like there is a lot of stock for sale. In other words, stock manipulation.
And yes, stock manipulation is illegal.
So how do they do this?
How to Manipulate Stock Through Short Selling
When the removal of the uptick rule was implemented on October 4, 2012, a short marking exempt designation (SME) was also introduced.
Via IIROC:
“The “short-marking exempt” designation is required to be applied to orders for qualifying accounts of arbitrageurs, market makers and “high-frequency traders” that typically generate a high volume and speed of orders on a fully automated basis, may have orders on both sides of the market on various marketplaces at the same time, and that adopt a “directionally neutral” strategy such that generally, the position in each security in the account is flat at the end of the trading day.”
In other words, as long as a firm adopts a “directionally neutral” strategy, such that generally, the position in each security in the account is flat at the end of the trading day, it doesn’t have to declare the short sale.
This was done because IIROC believes that the use of the SME order designation allows them to separately monitor the trading activities of those accounts which are actively buying and selling the same security without taking a directional position and that of actual short sale activity on accounts that may have adopted a “directional” position.
While this may have good intentions, it actually makes it easier for firms selling short to manipulate the price of stocks.
Spoof Trading
Here is Bloomberg’s take on Spoof Trading:
“Spoofing is when a trader enters deceptive orders tricking the rest of the market into thinking there’s more demand to buy or sell than there actually is.”
In the case of short selling, a trader would show pressure on the sell side through stacked sell orders, but remove them if the market begins to move higher.
These stacked sell orders are often viewed – especially by retail investors with a lack of market data – as weakness in a stock.
You may be wondering: What happens if buyers come into the market? Wouldn’t the sell orders be on the hook to buy the stock?
You see, these sell orders are often in small board lots (usually 100 shares) so that anytime the lead sell order is hit, the firm only has to sell a few shares short.
When this happens, the computers automatically adjust their sell orders higher, while still maintaining pressure on the stock by maintaining the multiple stacked sell orders – often times behind a real sell order.
This allows the short sellers to put downward pressure on a stock without having to declare a short because they remain “neutral” by buying just enough shares to end up with a flat position in the account at the end of the trading day.
And because the uptick rule was removed, short funds can now downtick a stock and still short the next day