The New York Stock Exchange will make history Monday when it converts all of its stocks to decimal pricing--ending two centuries of pricing in fractions.
The move, to be mirrored simultaneously by the American Stock Exchange, follows a five-month test during which 159 NYSE stocks traded in price increments of one penny instead of the 1/8 (12.5-cent) or 1/16 (6.25-cent) increments in which most stocks now trade.
On Monday, the Big Board makes a giant leap by switching all 3,500 of its stocks to decimals, ending for good the fractional minimum prices whose roots were in the Spanish empire's silver piece-of-eight coin--so called because it could be broken into eight bits.
The NYSE's archrival, the Nasdaq market, won't begin its decimal test phase until March 12, though Nasdaq says it will shift completely to decimal pricing by April 9, the deadline set by the Securities and Exchange Commission.
Market critics and regulators have long pushed for decimal pricing, saying there was no reason to continue a fractional system that helped guarantee a minimum "spread" between the bid and asked stock prices set by Wall Street dealers--and thus assured a minimum trading profit for those dealers, at investors' expense.
But analysts also warn that decimal pricing is likely to mean greater market volatility and more disputes over trade execution.
Though most foreign markets already trade in decimals, U.S. markets long insisted they needed upgraded technology to handle the higher volume of quotes and other information that comes with decimal pricing. For example, in a fractional system, there are only three price levels between $10.00 and $10.25. In a decimal system there are 24.
Even if the volume of shares traded stays constant, the volume of information "traffic" in the markets is expected to increase by 20% or more with decimalization, according to some estimates.
Major options markets still don't have enough computer capacity to handle one-penny price increments, so they will use increments of a nickel for NYSE stock options priced at $3 or less and a dime for those priced at more than $3, spokespersons said.
A study launched after the NYSE decimal test period began in September showed that, just as advocates predicted, the bid-asked price spreads on stocks shrank by an average of 38% on the NYSE and 47% on the Amex. The bid is the highest price a buyer is willing to pay for a stock at a given moment. The asked is the lowest price acceptable to a seller.
However, the study also indicated a trade-off in terms of "liquidity," or the ease of finding buyers or sellers at a particular price. Generally speaking, fewer shares were available at each price level under decimals versus under fractions.
A related concern is that the effectiveness of "limit" orders--orders to buy or sell a stock at a specific price, or better--could be reduced under decimal pricing. Experts say investors could find that professional traders are "stepping in front" of investors' limit orders.
For example, say you entered a limit order to buy a stock at $10 a share or less. A dealer who saw your order in the market could offer to buy at $10.01. If the stock price kept moving higher, the dealer's offer would top yours, and your trade would never go through.
Under fractional pricing, a dealer would have to offer at least 1/16th, or 6.25 cents, more than you to make the same trade.
"Missing out on a trade for a single penny would be so aggravating that I think many people who normally would enter a limit order will now use a market order," said Ted Weisberg, president of Seaport Securities and a veteran of more than 30 years on the NYSE floor.
Market orders are executed immediately at the prevailing price. But small investors in recent years have been counseled against using market orders, because in fast-moving markets the risk is high that the price you get will be much different than the price quoted when you entered the trade.
Tighter price spreads, lower liquidity and fewer limit orders probably will add up to more volatility in the market, Weisberg said.
When selling pressure starts pushing a stock down, he explained, it typically triggers standing limit orders to buy at lower price levels. As these orders get executed, they ease the downward pressure. Thus, if limit orders become less popular, it could reduce this "braking" action and make for quicker, scarier price declines.
Dealers, for their part, will see their bid-asked price spreads cut. But veteran trader Bernard Madoff said that professionals will find a way to make money. He noted that when the minimum price increment dropped in the late 1990s from 1/8 to 1/16--a "teenie," in Street parlance--market makers and NYSE specialists still saw their profits rise.
Madoff and Weisberg said decimal pricing also may provide more opportunities for such pros as NYSE "floor brokers."
Whereas investors--even professional money managers--can view on their computer screen the best available price for a stock and the number of shares offered at that price, they can't see how many shares are available within a few pennies of that price.
Floor brokers, who bill themselves as the eyes and ears of their customers away from the floor, can examine the computerized order books of the NYSE and glean such additional details. That service may become even more valuable beginning Monday.
Still, major changes are always viewed with some apprehension on Wall Street.
Weisberg recalled the anxiety that he felt in 1975 when fixed-price brokerage commissions were phased out. At 35, with young children, Weisberg worried whether he'd be able to continue making a living as a stockbroker.
"One of the older guys took me aside and said, 'Listen, kid, as long as an eighth is an eighth, nothing has changed,' " Weisberg said with a laugh.
"Then, of course, eighths became teenies, and Monday when the teenie becomes a penny, I would say that's a heck of a change," he said.