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November 1, 1999

Cover Story - A Penny for Your Troubles: On the Rocky Road to the Decimalization of U.S. Stock

By Peter Chapman

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  • Cover Story - A Penny for Your Troubles: On the Rocky Road to the Decimalization of U.S. Stock
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Decimalization is only seven months away from replacing the fractional system used in the U.S. for quoting stocks. Retail investors may be pleased but some institutional traders are downright apprehensive.

"The market moves fast enough as it is," said Gary Kaplowitz, head of Nasdaq trading at Fahnestock & Co. in New York.

"Decimalization is going to increase the frequency of price fluctuations. Quotes will be all over the place, making it harder to get in and out of positions," he added.

Kaplowitz is worried about a Securities Industry Association-led plan to move the industry into a decimal-based trading environment - a plan that would see the current minimum increment tumbling lower.

Today's minimum tick of one-sixteenth, or 6.25 cents, could drop to a penny on many of the most heavily traded stocks. That could encourage traders to quote more small orders at the inside price. If it only costs a penny a share to trade, more investors will likely participate in the market. But that penny a share scenario would make it more difficult for Kaplowitz to execute large orders. He would have to work far more 100-share orders and at a faster rate than he does today.

The Outcome

Rapid-fire trading is possibly just one far-reaching result of how decimalization will affect both buyside and sellside traders. The sellside will see thinner spreads on large-cap Nasdaq stocks, such as Microsoft, Cisco and Dell Computer, according to the experts. The buyside will see reduced depth on listed markets, they add. The individual investor, however, is expected to be the big winner of stock prices in decimals.

But then that's the point. Decimalization was forced on the markets by Congress in 1997 partly to save retail investors billions of dollars per year. That was supposed to happen by the aforementioned reduction in minimum tick sizes by market centers like the New York Stock Exchange and Nasdaq.

Smaller trading increments would intensify competition among all sorts of limit order traders. Market makers, day-traders, hedge funds, and arbitrageurs would all try to better each other's quotes, leading to price improvement for the customer.

The "Common Cents Stock Pricing Act," or HR 1053, was introduced in the House by representatives Michael Oxley (R-Ohio) and Edward Markey (D-Mass) in March 1997. "A modern decimal system is better for small investors," Oxley said. "People are being eighth-ed and sixteenth-ed right out of their stock profits."

The bill required decimalization as quickly as the SEC thought it could handle it. Three months after the legislation was introduced, the NYSE voted to trade in decimals and cut the minimum trading increment from one-eighth to one-sixteenth. Oxley and Markey then pulled their bill. Nasdaq soon announced its own move to decimals. The SIA recently sent its plan to the Securities and Exchange Commission, calling for decimal trading to begin on July 3, 2000. Stocks would trade in nickel increments for three months, then in whatever increments decided upon by individual market centers. Most expect the tick to drop to a penny for the most active issues.