The switch to trading stocks in units of a penny rather than fractions of one-eighth of a dollar was touted by supporters as a way to bring U.S. markets up to speed with the rest of the world, and as a potential savings for small investors. But market observers say decimal trading in a pilot group of securities has shown there's also a casualty: the value of the stock quote itself.
While the gap between the price at which a stock is offered and the price bid by investors appears to shrink with the change, which can benefit investors, stocks often may not be available for purchase at the price shown.
"The quotation is not all that meaningful," says Lee Korins, president of the
Security Traders Association
. "What's the real market? ... It just shows that there's not a lot of liquidity in these penny increments."
An analysis of data from a group of securities that began trading in decimals this summer, including 64 stocks on the
New York Stock Exchange
and 48 stocks on the
American Stock Exchange
, found that the "depth" of quotes was dramatically reduced for those trading in pennies. The depth -- the number of shares available at a given price -- dropped by an average of almost 63 % compared with trading in fractions, and as much as 75 % in the case of one pilot stock,
, according to an analysis by Robert Wood, a
University of Memphis
Hide and Seek
That will be particularly important for institutional investors, Korins says. He's already heard anecdotal evidence of larger stock orders requiring numerous transactions at various prices to fill under decimals, as opposed to being traded in large blocks as they were under fractions. Observers don't expect the reduced depth to affect individual investors who buy stocks in small increments. But many individual investors own securities through mutual funds, which will feel the impact.
study of the decimal pilot program completed in November for the
Securities Industry Association
, which represents brokerage firms, found the conversion to decimals made it more difficult for investors to find shares at a price in "institutional" quantities of 2,000 to 10,000 shares. The report concluded that while trading in decimals will make stock quotes easier to understand, it's still too early to determine what economic benefits the change might have for investors.
Jim Dascoli, head trader at
McKinley Capital Management
, a New York hedge fund, says securities traded in decimals are proving to be more confusing, in a sense, because it's become difficult to find a price that's real.
"It's been a very frustrating and very difficult experience to learn how to trade them," Dascoli says.
So traders interested in securities listed on the NYSE will have to rely more on information they get from the exchange floor than on displayed price quotes to find out what's available in securities traded in pennies.
And at the Nasdaq
Or, in the case of the
market, which won't begin switching to decimal trading until next year, that will require going to market makers rather than viewing the publicly quoted price, says Korins.
At the NYSE, securities are bought and sold on a trading floor, with orders handled by floor brokers and the trades arranged by specialist firms. On the Nasdaq, buyers and sellers are brought together electronically, and the trading is accommodated by market-making firms that step in to purchase or sell securities at publicly quoted prices.
"Once it gets to Nasdaq, where a stock can currently trade at your price without getting filled, it will even further reduce transparency," or the ability to readily see what's happening in the market, Dascoli says. "I don't really see how it supposedly helps the small investor."
It's supposed help individual investors by reducing bid-ask spreads. The closer the investor is able to come to matching his or her bid with a sale price, the more money the investor saves, according to that argument, because the difference between the bid and ask goes to a middleman -- the market maker. Decimalization is supposed to trim the middleman's take.
The Good in It
Proponents still believe decimals will help investors. U.S. Rep. Tom Bliley, chairman of the
House Commerce Committee
and a fervent proponent, welcomed early analysis of the decimal pilot program, including a study by the
General Accounting Office
"The GAO's findings echo what I've been saying for many years. The move to decimals makes our markets more competitive, and will save investors billions annually," Bliley, R-Va., said in a recent statement.
But it will take more time to accurately assess the benefits of reduced bid-ask price spreads, says John Panchery, vice president and decimalization project manager with the Securities Industry Association. "Certainly we have seen spreads narrow," Panchery says. "Has it really saved anything? Has there been a savings for investors? That yet has to be analyzed."
And reducing bid-ask spreads can cut both ways, says Korins, the trader. If the price you bid becomes closer to the price offered, you may save money that would otherwise have gone to a middleman. But the converse is also true: The price you offer when trying to sell shares also becomes closer to the price bid, meaning less profit from the sale.
"The problem with the market is it's a zero-sum game," he says. "I guess it depends on which side of the market the public is in if there's going to be savings."
The NYSE Monday is to
add an additional 97 stocks to its decimal test program, and the Amex is to
convert 15 options. The Amex is to convert completely to pricing in decimals by Jan. 31.