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October 27, 2012 – Comments (8)

The WSJ is reporting that the SEC is considering bringing back fractional pricing (may req subscription).  The title for this post is what the current ask shown for Apple on Yahoo would look like if fractional pricing returned.  Years ago, stocks were priced in dollars and fractions with 1/16 as the smallest quote increment.

According to the article,

Those championing the fraction's return say it would spur securities firms to buy and sell more shares of some companies by making it more profitable for them to do so. Opponents say fractions would increase trading costs for investors with little or no benefit to companies.

I think both statements are correct.  Since the 'more profitable' part for securities firms would come out of stock investor's pockets and I, along with many here at the Fool, am a stock investor, put me in the 'opponents' camp on this one.

More quotes and comments:

If you move away from penny pricing, "investment banks will be able to make enough money trading…to write research and re-create the spark in the engine," said Jeffrey Solomon, chief executive of Cowen Group Inc.

Um, yeah, more trading and investment bank research, that's what this [lack of] recovery needs! Even if more investment bank research were needed, why should it be funded through bigger bid-ask spreads that make every stock trade pay part of the tab whether the buyer or seller have any interest in, use for or even access to the research they're paying for?

If your goal is to lure investors back into the market, raising their transaction costs doesn't seem like a particularly good way to do it," said Barbara Roper, director of investor protection at the Consumer Federation of America

Based on this quote alone, Ms. Roper should be on the short list for next chair of the SEC.

You'd think the SEC would have more important things on its plate than debating decimals vs. fractions.  And if fractions, why 1/2, 1/4, 1/8, 1/16?  How about 1/1000 or 1/1024, maybe 1/625?  In this case, it boils down to bigger bid-ask spreads.  

Off to peruse the SEC site and see if I can find any more on this apparent stupidity.  

Fool on!  Russ

 

 

8 Comments – Post Your Own

#1) On October 27, 2012 at 1:34 PM, rd80 (98.44) wrote:

SEC Report on tick size that was required by the JOBS Act.

http://www.sec.gov/news/studies/2012/decimalization-072012.pdf

 

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#2) On October 27, 2012 at 4:29 PM, anchak (99.85) wrote:

With you Russ!

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#3) On October 27, 2012 at 5:29 PM, awallejr (83.80) wrote:

I never liked the fractional trading as an investor.  I was very happy with decimilization since my costs really did decline.  On large caps I do use market orders when the difference in the bid/ask is only 1 penny, smaller caps I use limit orders.

So the plan is to make the investment houses more money at the expense of the retail investor?  Wow just wow.

I would, however, like to hear how this might impact HFTs.

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#4) On October 27, 2012 at 8:05 PM, rd80 (98.44) wrote:

Well, I'm a little smarter.

First, AAPL's ask in the title wasn't a very good choice since the pricing change would only apply to small companies.

A pricing change, if adapted, wouldn't necesarily return to fractional pricing.  It could be decimal, but with bids in some increment other than one-penny - maybe 5 cents.  The JOBS Act did say no more than 10 cents.

I found some mention of HFT, but no predicitions on how this might impact it.  There is discussion of the order book and how penny pricing is more likely to result in large orders being broken up to be executed.  The studies show roughly the same amount of liquidity around the market price, but with smaller ticks, there are more steps.

The SEC report I linked in #1 states " According to the IPO Task Force Report, the impact of decimalization has been twofold. First, market structure changes associated with decimalization favor short-term trading strategies over long-term fundamental strategies.5 For smaller public company stocks with lower liquidity, the lack of fundamental strategies results in trading volume that is too low “to make money for the investment bank’s trading desk.”6"

The main focus of this is the belief that larger tick sizes would help smaller companies launch IPOs.  Much of the discussion is that investment house trading with larger ticks is more profitable and, therefore, they can afford analyst coverage to promote the stocks and drum up investor demand.

There are some studies that show a very clear drop off in under $50 mil IPOs after decimalization in 2001.

More of my thoughts:

I really don't see how the tick size can make that much difference in the number of small IPOs.  For starters, $50 mil in the 1990's isn't the same as $50 million today.  The studies do mention that tick size isn't the only thing that's changed.  The SEC and the studies on its web site don't do a good job of addressing other factors that, IMHO, could have much more impact.  Like lower commissions, online trading, computer algorithms - the whole landscape of stock investing has changed dramatically in the last 10-20 years and tick size is just one element.

As for market structure changes favoring trading over buy-and-hold, it seems to me that online trading, low commissions, and other changes would have had a much larger impact than tick size.

The drop in small IPOs does correlate well with the change from fractions to penny ticks.  But, the SEC report and the studies I read (skimmed is more like it) didn't provide much to make the jump from correlation to causation or address how other changes to the markets and technology or just inflation may have played a role in the smaller number of $50 million IPOs.

I just don't see the case for larger ticks and certainly not for fractional ticks.  Much of the argument was centered around funding for analyst research and investment bank trading profits - boo hoo.  If there's really a market demand for more analyst research, there are lots of ways to meet it without 'eighthing investors.  Independent newsletters or subscription-based  research jump to mind.

And, many thanks for the comments.

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#5) On October 28, 2012 at 12:07 AM, Frankydontfailme (27.25) wrote:

I sleep well knowing the great folks at the SEC serve to protect.

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#6) On October 28, 2012 at 11:27 AM, GundersonGroup (28.61) wrote:

Looks like Mary Schapiro is trying to increase her sign-on bonus at whatever cockroach hotel she ends up at post SEC.

 Apparently HFT firms are not vacuuming up OPM fast enough.

 

As for this...

5 For smaller public company stocks with lower liquidity, the lack of fundamental strategies results in trading volume that is too low “to make money for the investment bank’s trading desk.

Equity underwriting standards were lowered for the same reason mortgage underwriting standards were lowered. You want huge amounts of shortable garbage. An underwriter can naked short as much of a IPO as it wants to without margin issues or carry costs as part of its market making efforts. The excuse that an investment bank does not make money on these offerings is ludicrous.

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#7) On October 29, 2012 at 8:05 AM, lemoneater (82.05) wrote:

Wow, while we're at it lets bring back the cuniform alphabet.

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#8) On October 30, 2012 at 9:42 AM, Mary953 (74.21) wrote:

 Years ago, stocks were priced in dollars and fractions with 1/16 as the smallest quote increment.

And how depressing to realize that when I first started investing and learning about the market, they were using fractions still (but only to the eighth).  The commission for anything other than an even lot was so expensive that it was hardly worth the purchase price.  The stock market seemed all but closed to a beginning investor as a way to make any money at all unless you had a really good crystal ball..  *sigh* 

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