All Investors Aren’t Sold on Decimal Stock Prices
As the Nasdaq Stock Market today launches the first phase of its switch to decimal pricing, controversy still surrounds the issue on the New York Stock Exchange, which got rid of fractional share pricing in January.
On Nasdaq, which Friday saw its premier technology stocks hammered to new multiyear lows, 15 issues--mostly tech names--will begin trading in penny increments today instead of in fractions.
So far, early studies confirm the Wall Street consensus that penny pricing on the NYSE has shaved transaction costs for small investors while making life tougher for institutions that trade in “blocks” of 10,000 or more shares.
But this seemingly democratic result has been challenged by the Investment Company Institute, the trade group for the mutual fund industry. The ICI argued in a recent letter to NYSE Chairman Richard Grasso that anything that hampers institutional trading ultimately hurts the funds and thus their small-investor owners.
The problem is what Wall Street pros now call “getting pennied”: when, for instance, an institutional investor’s “limit” order to buy a large block of stock at $20 a share or better is beaten by a specialist--one of the NYSE pros designated to facilitate trading on the exchange floor--who steps in front of that order to offer $20.01 for a smaller number of shares.
If the stock keeps moving up in the trading session the specialist can make a quick profit, while the institution’s block order doesn’t get filled. If instead the stock falls, the specialist can turn around and sell the shares to the institution at its still-effective bid of $20 or lower. The specialist may lose on the trade but the loss may be as little as a penny a share.
Professional traders always have had the ability to step in front of large limit orders this way. But when NYSE stocks traded in fractions, the smallest price increment was 1/16th, or 6.25 cents, so a wrong guess could cost a trader six times as much as it might now.
Since the NYSE shifted entirely to decimal pricing Jan. 29, some institutions have pressed the NYSE and the Securities and Exchange Commission to scrap penny pricing for a minimum increment of a nickel, even though that could bring howls from small investors.
The ICI, in its March 1 letter to Grasso, recommended leaving the penny increment alone but changing certain NYSE rules to protect large investors’ orders and increase the chance that they will be executed in a timely way.
The ICI notes that institutions would gladly forgo the opportunity for price improvement--that is, the chance of buying a stock at $19.99 or $19.98 in the example above--in exchange for more certainty of getting a trade done.
“The time for decimals is now and they’re here to stay,” said John Wheeler, head of equity trading at American Century Funds in Kansas City, Mo. Even so, he said, current NYSE rules should be altered to improve the handling of large stock orders.
The NYSE has set up a panel to investigate complaints about decimal pricing. A report is expected in the spring.
Academic studies of NYSE decimal trading thus far confirm the prevailing opinion that price spreads--the difference between the best “buy” and best “sell” offers for stocks at any given moment--have narrowed, thus reducing investor transaction costs, at least for small orders.
The flip side, however, is that depth--the number of shares offered at a particular price--has decreased sharply because investors have so many more pricing options than under fractional pricing.
In short, it’s cheaper to get a small deal done but harder to execute a large trade.
As a result, traders say, the number of large limit orders (orders to buy or sell at a specific price or better) being placed on the NYSE is shrinking, and many block trades are being done on regional stock exchanges that offer more protection from trading pros trying to step in front of institutional trades.
On Nasdaq, concerns about the shift to decimal trading center on the Nasdaq system’s capabilities rather than market rules. Some traders have asked Nasdaq to delay implementation for fear that the market’s computers won’t be able to cope with the surge in price data that comes with quoting in penny increments rather than fractions.
Fears of a technological snafu were hardly eased Friday when one of Nasdaq’s electronic trading systems broke down for 10 minutes in the middle of the day.
Until now, Nasdaq’s system has been equipped to display quotes only in 1/16ths. However, there has long been no limit on the price increment an investor can enter on electronic systems. Indeed, electronic networks that compete with Nasdaq, mostly for institutional trades, have for years allowed investors to enter quotes in increments even smaller than a penny--for example, in 1/128ths.
Nasdaq will roll out decimal trading in three steps: Today, 15 stocks begin trading in penny increments; 180 names will be added March 29 and full implementation is supposed to follow April 9, the deadline set last year by the SEC.
Whether shifting to decimals has any effect on Nasdaq’s bear market remains to be seen, traders say. The Nasdaq composite index sank 5.4% on Friday to 2,052.78, its lowest since December 1998, amid more earnings warnings from tech firms.
Nasdaq stocks to begin trading in decimals today are Coastal Caribbean Oil & Minerals (ticker symbol: COCBF) from the Over the Counter Bulletin Board, plus Brocade Communications (BRCD), Commerce One (CMRC), Copper Mountain Networks (CMNT), Cree (CREE), Extreme Networks (EXTR), Inktomi (INKT), Integrated Device Technology (IDTI), Micromuse (MUSE), Newport (NEWP), OpenWave Systems (OPWV), Rambus (RMBS), Redback Networks (RBAK), Research in Motion (RIMM) and VerticalNet (VERT).
