What Is a Downtick?
A downtick is a transaction for a financial instrument that occurs at a lower price than the previous transaction. A downtick occurs when a stock’s price decreases in relation to the last trade.
- A downtick refers to a transaction of a financial instrument that occurs at a price lower than the previously transacted price.
- A tick is the measure of the upward or downward movement of the price of a security.
- A downtick stands in contrast to an uptick, which is a transaction marked by an increase in price.
- The minimum tick size for trading stocks above $1 is $0.01.
- Short selling is not permitted on a downtick of more than 10% as stipulated by the Securities and Exchange Commission (SEC).
- Short selling is considered to be a large reason for stock market crashes, such as the 1929 market crash that led to the Great Depression.
Understanding a Downtick
A downtick occurs when a transaction price is followed by a decreased transaction price. This is commonly used in reference to stocks, but it can also be extended to commodities and other forms of financial securities. A downtick is in contrast to an uptickwhich refers to a trade in which the price increases from the previous price.
For instance, if stock ABC traded at $10, and the next trade occurs at a price below $10, ABC is on a downtick. If the stock price moved above $10 instead of decreasing, then the transaction is on an uptick.
A tick is a measure of the minimum upward or downward movement of the price of a security, and since 2001, the minimum tick size for trading stocks above $1 is $0.01.
A downtick is a natural part of market fluctuations and can have a number of causes, including an increase in supply over demand for a given stock or a lowered valuation of a company, though a downtick does not necessarily indicate an economic downturn or that a company is performing poorly.
Short selling a stock is not allowed on a downtick, as stipulated by the Securities and Exchange Commission (SEC) uptick rule.
A short sale, or the sale of an asset that a seller does not own, is only permitted when the transaction is entered at a higher price than the previous trade. Originally introduced in the Securities Exchange Act of 1934 and implemented in 1938, the uptick rule is designed to prevent short sellers from adding to the downward momentum of an asset experiencing a decline.
Short selling has been regarded as a reason for many stock market crashes, particularly the market crash of October 1929 that led to the Great Depression. It is for such reasons that regulatory bodies have sought to either prevent short selling or to put restrictions around it.
While the uptick rule was eliminated in 2007, in 2010, the SEC instituted an alternative uptick rule to restrict short selling on a stock price that drops more than 10% in one day.
The New York Stock Exchange (NYSE) implements a set of restrictions to ensure orderliness when the market experiences significant daily movements. While many of these restrictions are executed when the market experiences a significant downturn, the NYSE used to implement one restriction in a market upturn, which was known as the downtick-uptick test, or Rule 80A, under the NYSE.
The downtick-uptick rule was used to restrict the volume of trades on S&P 500 stocks whenever the NYSE Composite Index (previously the Dow Jones Industrial Average) gained or lost more than 2% from the previous trading day. The restriction was designed to control large-volume trades when the market was volatile because too many trades could magnify fluctuations and harm the exchange, and eventually, the overall financial markets.
The downtick-uptick rule, also sometimes known as the collar rule or the index arbitrage tick test, was eliminated by the SEC in 2007. Many financial experts have discussed the value of bringing back Rule 80A, as since the rule was removed, there has been an increase in the likelihood of large market movements, bringing increased instability to the markets compared to when the rule was in place.