Commentary

Salil Pachare and Ilia Rainer
Traders Magazine Online News

Does the Tick Size Affect Stock Prices?

The Securities and Exchange Commission has recently released a whitepaper examining the change in tick sizes on trading based on data it collected during the Tick Size Pilot.

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August 11, 2008

Unshackled

By Peter Chapman

The Citadel executive also attributes the attraction to the fact that each market center is distinct in its own way. A market maker can make money trading on the NYSE, for instance, simply because it is not Nasdaq or BATS or another marketplace. "It's not a zero-sum game," Fitzpatrick says. "Every new destination that has a reasonable amount of liquidity is a potential place to quote."

The New York's proposal, which must be opened to industry comment and approved by the Securities and Exchange Commission, furthers the transformation of the specialist that began with the exchange's Hybrid proposal in 2004. Indeed, it is the latest rule change in a series of changes since 2004 giving the specialist freer rein (see sidebar). Ever since the introduction of Regulation NMS and the NYSE's Hybrid marketplace, the exchange has argued that the old rules governing specialist behavior had lost their relevance.

Before Hybrid, the specialist acted primarily as an agent for other brokers, an auctioneer and a dealer when necessary. Any trading for his own account was done to minimize price fluctuations and in the event that there were no other buyers or sellers. His role as a dealer was to maintain a "fair and orderly market," And he was not permitted to trade opportunistically.

Surge

But with the introduction of the Hybrid market, the specialist became more of a competitor and less of a facilitator. Although he still had to refrain from trading unless absolutely necessary, the specialist could compete more freely against floor brokers for fills. At the same time, the surge in electronic trading that accompanied Hybrid rendered most of his agency and auctioneer functions obsolete.

Despite all the tweaks to the rules over the past four years, the switch to electronic trading at the New York has proved too much for the specialist. Any advantages he gained have apparently done little good. His participation in the market is at an all-time low, as is his profitability. Two specialists, Van der Moolen and Susquehanna, abandoned their books entirely. All specialist firms have been slimmed down through layoffs.

The near-total replacement of open-outcry trading with automatic executions has relegated the floor to not much more than office space. Brokers and dealers transact almost all of their business over computers. Hybrid effectively turned the exchange into just another ECN, marginalizing the specialist.

On the surface, the exchange's proposed new model resembles those of the NYSE's all-electronic competitors. Aggressive market makers will bring in the business. Trading on an electronic book will be open to all comers. But when it comes to the relative status of its constituencies-there are three: floor brokers, market makers and upstairs traders-the New York's philosophy is decidedly different.

For the most part, the treatment of traders by ECNs and ECN-like exchanges is democratic. Whoever sets the best price first gets filled first. Whoever sets it second gets the next chunk, and so on. They use a strict price-and-time-priority schema that does not discriminate against any given class of trader.