The average stock market investor would have experienced an average return of about $10.72 percent, based on the S&P, had they stayed invested in the stock market for the past 30 years. That represents an annual return of 8.29 percent once the performance has been adjusted for inflation.
It’s safe to say that investing in the stock market pays, especially if you are willing to buy and hold your stocks for a while. It also helps if you learn all manner of trading lingo, such as short exempt volume, short sell, FIFO or LIFO, among others. Doing so will enable you to understand what to do and the context in which those actions can be taken.
But what if you want quick returns? And what if you want to take advantage of short-term price changes in the market? Could you take advantage of share price decreases to make money when others are not doing so?
In that case, you could adopt other investment strategies, such as short selling. It is actually within this strategy that learning terms, such as short exempt volume and short sell exempt, will come in handy.
Read More: The Difference Between Stakes, Shares and Stocks
What Is Short Selling?
Short selling is a stock market investment strategy that involves borrowing a security from a lender, usually the broker. And then, you sell the borrowed stock in the open market.
The goal of a short sale investor is to wait until the share prices fall so you can buy back the exact number of shares at a much lower price. If everything goes as anticipated, you will make money on the net difference between the higher price at which you sold the borrowed stock and the lower price at which you bought them back.
There is just one main problem: it doesn’t always work. If the stock price continues to increase, you would still need to buy back the security you sold, albeit at a higher price, to return it to the lender by the set deadline. When that happens, you would make a loss.
Such a nightmarish investment scenario is known as a short squeeze. And investors who are caught up in the nightmare may be forced to continue paying interest on the stock they have borrowed or buy back the sold securities at a significant loss.
1. Uptick vs. Downtick
When a stock sells at a higher price than the previous transaction, the situation is known as an uptick. But when a security sells at a lower price than the previous value, that situation is known as a downtick.
For example, when stock ABC sells at $20 today and $30 during the next trade, it is said to be on an uptick. But if the subsequent trade is $15, we would consider it to be on a downtick.
2. The Uptick Rule
According to the United States Securities and Exchange Commission’s (SEC’s) uptick rule, which was created in 1938, one can only perform a short sale on a stock that is on an uptick. If the stock’s last price movements had already shown signs of taking a downward turn, you could not engage in short selling it.
In 2007, the rule was eliminated completely because it was considered ineffective in many quarters. But the SEC had already introduced an alternative uptick rule that stated that when a stock’s price falls by 10 percent or more compared to what it was at the previous closing, it cannot be part of a short sale. This is known as Regulation SHO - Regulation of Short Sales.
Read More: Pros & Cons of Buying Short Sales
3. Short Sell Exempt and Short Exempt Volume
If a short sale order is excluded from the price test set by the SEC’s Regulation SHO, it is said to be short exempt or short sell exempt. In such a case, you could sell the stock while it’s on a downtick beyond the set limits.
Typically, the current stock market rules state that stocks must be labeled “short,” “long” or “short exempt." As an investor who intends to sell, it is your responsibility to choose the right label for your needs, depending on whether you meet the criteria of security owner.
For the last category, short selling may occur even in circumstances where they would have been restricted otherwise.
On the other hand, short exempt volume refers to the volume of shares that qualify as short exempt. No short selling will occur beyond the set limit.
Remember, short selling is a risk. But if you play your cards right, it could pay off for you. However, if you make a mistake, you could end up paying heavily. So familiarize yourself intimately with the investment strategy before deciding what to do.
- SoFi: What Is the Average Stock Market Return?
- Investor.Gov: Stock Purchases and Sales: Long and Short
- Schwab: The Ins and Outs of Short Selling
- Business Insider: What is a short squeeze? Understanding why they happen and how they work
- The Business Professor: Uptick (Trading) - Explained
- The Business Professor: Downtick (Financial Markets) - Explained
- ECFR.Gov: Regulation SHO - Regulation of Short Sales
- SEC.Gov: Key Points About Regulation SHO
I hold a BS in Computer Science and have been a freelance writer since 2011. When I am not writing, I enjoy reading, watching cooking and lifestyle shows, and fantasizing about world travels.