A case for reviewing the 10% rule imposed on the Stock Market
Brokers tell us that a price control has been imposed by the Securities as Exchange Commission on all shares traded on the market. They oppose the rule. But long term investors seem to like the Rule.
It has renewed the debate about the roles of governments and markets in protecting investors from themselves and from one and all. They point out that nowhere in the world is such a price band fixed by the Regulatory Authority.
They say that other stock exchanges have only circuit breakers where if an individual share goes up too steeply to a level far above what its fundamentals warrant they halt the trading for an hour or for the rest of the day and make inquires from the relevant Listed company whether they have price sensitive information which could have leaked out to a few persons.
The rationale is not to interfere with the pricing mechanism but to ensure equality in the disclosure of price sensitive information. The listed company will issue its statement and thereafter the halt in trading is lifted. Should not the Securitas Exchange Commission review the present rule and adopt circuit breakers for individual shares instead.
Speculation is not necessarily bad but the regulatory authority is obliged not to allow too much speculation so as to create bubbles in individual shares or in the market as a whole. The case for SEC intervention was based on the unusually high share prices of a few companies whose fundamental values were close to zero or even negative.
It is worth noting that for the price of an asset to exceed its fundamental value; astute investors who buy the asset should believe they might be able to sell it at some point in the future. This is because a forward looking investor would never purchase an asset worth more than its fundamental value with the intent of keeping it forever. If he did, he would be paying more for the asset than it would ever earn him in dividends. It is only under special circumstances that all investors can credibly believe they will eventually be able to sell the asset to someone else.
By imposing the 10% rule the SEC has resorted to overkill. It will shut out all day traders and short term traders, the brokers say. In the past only those who were physically present at the Trading Floor could engage in day trading. But with the introduction of Information Technology on-line trading packages are available for customers to trade from their laptops wherever they are. So a large number of customers now engage in day trading and if this segment of the market is shut out then the market turnover is likely to decline. In recent months turnover reached Rs.5 billion on certain days. But after the price band the turnover was below Rs 1 billion.
If the SEC persists with the Rule the market is likely to dry up as far as turnover is concerned. It is the day traders who provide the momentum for the stock market. Stock markets all over the world are volatile but our stocks are more volatile because there is no short selling and no derivative contracts. Traders have to first buy the share before it can be sold. So when they wish to buy a particular share investors seem to push its price down and then when they buy it, it automatically rises. So the SEC should consider the introduction of short selling contracts. The present rule limits the liquidity of shares arbitrarily since a seller may be willing to sell below the 10% or a buyer may want to put a higher bid to get priority. Both are now unable to do so.
Long term investors also wish to place orders valid for five days at a limit price. They too are unable to place orders for five days or even for two days since orders must be only for the day. These are barriers placed on the market for no apparent reasons.
We urge the SEC to think of other ways to discourage (not prohibit) day traders by insisting say that their margins must be intact at the time of placing the order. It is the trading on margin provided by the brokerage houses that gives the necessary leverage to investors to buy shares at higher and higher prices.