WHAT IS 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.
BREAKING DOWN 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 securities. This is as opposed to an uptick, which refers to a trade in which the price increases.
For instance, if stock ABC traded at $10, and the next trade occurs at a price below $10, ABC is on a downtick.
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 1 cent.
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. A downtick does not necessarily indicate a downturn.
The Uptick Rule
Short selling a stock is not allowed on a downtick, thanks to the rule issued by the Securities and Exchange Commission, commonly known the 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. While this 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 percent in one day.
The Downtick-Uptick Test
The New York Stock Exchange implements a set of restrictions to ensure orderliness when the market experiences significant daily movement. While many of these restrictions are executed when the market experiences a significant downturn, the NYSE also implements one restriction in a market upturn, which is known as the downtick-uptick test, or Rule 80A under the NYSE.
The downtick-uptick rule is used to restrict the volume of trades whenever the Dow Jones Industrial Average gains or loses more than 2 percent from the previous trading day. The restriction is designed to control large-volume trades when the market is volatile, as such trades can magnify fluctuations and harm the exchange.
The downtick-uptick rule, also sometimes known as the collar rule or the index arbitrage tick test, was eliminated by the SEC in 2007, but was reinstated in 2009.