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This is the second part of a three-part series on the "plus-tick rule," which requires that any person selling a stock short must do so only at the price which is the higher of the last two discrete transactions. Part I looked at how the rule addresses imbalances in the market, and we began to make the case for why the rule should be restored.
Today, in Part II, we will discuss certain obscure but significant risks built into certain market practices such as basket trading and the use of leverage, and examine some of the unintended consequences of having eliminated the rule to the detriment of the original purpose of capital markets.
In Part III we will describe how the rule has been strengthened and weakened at different times over the past two decades, show how the market acted during those times, and describe the process whereby the rule was eliminated in July of 2007.
Why We Need the Plus-Tick Rule, Part IITechnology has demonstrated time and again that it is possible to increase productivity, which can sometimes be viewed, in a way, as increasing the amount of reward for a given level of risk. Often, however, what looks like a great reduction in risk can be seen as more modest as we learn more about unintended consequences -- think of suitcase-sized nukes, for example. Quantitative investing has been around for so long that the term has lost almost as much descriptive usefulness as the term "hedge fund." I will use it to describe the practice of looking for patterns of information which can be predictive of the price movements of securities to an extent where it is possible to take advantage, usually using computer power.
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