Joseph, Here's a good article today on decimalization:
charlotte.com
Published Sunday, August 15, 1999
When exchanges switch to decimals, will smaller spread be boon or bane?
By BILL DEENER -- Dallas Morning News
A check of one of your stocks shows it moved from 7 1/8 a share to 7 3/16. Now quickly, did you make a profit? How much profit and how much is that in dollars and cents?
For more than a century, U.S. stock exchanges have quoted share prices in fractions, even though converting eighths and sixteenths to decimals can sometimes give pause to even the most math-savvy investors.
But that should change by next summer, when both the New York Stock Exchange and the Nasdaq Stock Market are expected to scrap fractions in favor of decimals.
While ``decimalization' may sound sinister, it isn't. It just means stock prices would be quoted the same as the price of a gallon of milk in plain dollars and cents. A stock at the current price of 7 1/8 would be listed as $7.13, and 7 3/16 becomes $7.19.
``Investors won't have to deal with converting fractions anymore to determine how their investments are faring,' said Nasdaq spokesman Scott Peterson.
The idea of changing from fractions to decimals has been around for 20 years but gathered steam in June 1997. That's when the NYSE voted to change the standard stock trading increment from 1/8 to 1/16 as an interim step to decimalization. NYSE chairman Richard Grasso and many prominent lawmakers praised the move to decimalization as a ``victory for investors.'
Now the Securities & Exchange Commission, which regulates the securities industry, is proposing industrywide implementation by next June, and Wall Street appears prepared to go along. But it's not clear at this point exactly when that will happen.
``The NYSE systems are ready, and we are working with the industry to coordinate decimalization,' said NYSE spokeswoman Diana DeSocio. The Nasdaq is also committed to the project, but Peterson said there's still a question as to whether the Nasdaq and its member firms will be ready by the SEC's target date.
``We have dedicated the resources, and we have launched a decimalization management office, but it's a matter of making sure we do it right,' Peterson said.
Converting to decimals is straightforward, and most securities industry officials support the notion. More uncertain is how wide to make the pricing increments. The exchanges ultimately will decide this issue, but it's far from resolved.
Two proposals are being considered, according to the Securities Industry Association, an industry trade group. The first plan calls for pricing increments of 5 cents, such as $7.05, then $7.10 and so on. This means there would be 20 increments or pricing points within a dollar, not much different than the current 16.
The other plan calls for penny increments: $7.01, then $7.02 and so on, which means there would be 100 price points within a dollar. The SEC is allowing the industry to work through the debate, but in general it favors smaller increments, said commission spokesman Chris Ullman.
The conventional belief is that a penny increment would result in smaller spreads -- the difference between the price a buyer is willing to pay for a stock and the price a seller is willing to accept.
Matthew Spiegel, professor of finance at Yale University, compared pricing a stock trade with haggling over a car deal. A prospective buyer wouldn't have much bargaining power if the car were priced in $1,000 increments.
``You can't really negotiate that much, because you can't shave a few hundred dollars off the price,' Spiegel said. ``My view is that there is no increment too small.'
Small spreads are especially advantageous for active traders, because the stock price only has to rise a small amount for them to sell at a profit. For example, a typical spread now is 1/16, or 6 1/4 cents. That means investors can buy a stock, and five minutes later if it rises more than 1/16, they can sell it for a profit. If the spread were a penny, it would be even easier to make a profit, Spiegel said.
Spreads are less important for long-term investors, because they often hold stocks for years, and tiny daily profits are immaterial.
Online trader Elizabeth Walker, 44, of Bedford, said that while she understands the benefits of smaller spreads, she's not so sure that decimalization is the answer.
``I don't have any problems with fractions now,' Walker said. ``It may be easier for some people to understand, but I don't think I will make any more money.'
Some fear that if the spreads narrow to a penny, market liquidity may actually be jeopardized. That's because the profits of the so-called market makers -- the brokerage firms and specialists who stand ready to buy and sell stocks to help market flow -- would be so slim that some would refuse to buy some stocks.
``If the spreads get too thin, the market makers would not be willing to commit their own capital to facilitate trading in that stock,' said John Baranko, chief equity trader for Strong Funds Inc., a Milwaukee mutual fund company.
Michael Goldstein, an economist at the University of Colorado who wrote a research paper for the NYSE, is also concerned about 1-cent spreads, but for a different reason.
He found that liquidity, the ease with which buyers or sellers can be found in the marketplace, was reduced in 1997 when the typical spread was trimmed from 1/8 to 1/16 because the number of so-called limit orders declined. A limit order refers to an investor setting a specific price at which he is willing to buy or sell a stock, as opposed to a market order, which is executed at whatever the market price is at the time the trade is completed.
With smaller spreads, it's easier for a limit order placed late in the day to take precedence over an earlier order that offers to pay a penny or two less for the stock, Goldstein said. Frustrated investors might react by not trading at all, he said, reducing the amount of stock in circulation and lowering the market's liquidity.
``Think of it as two lines,' Goldstein said. ``In one line, people are breaking in front of each other. In the other, everyone is staying in place. Now, which one would you want to be in?'
Cost estimates for converting to decimalization aren't available. By way of comparison, though, the Nasdaq spent $55 million on its Y2K compliance program. Most brokerage firms and mutual fund companies are just starting to assess the expense.
``Most of our computer systems already handle trades in decimals,' said Baranko of Strong Funds. ``This won't affect us at all.'
However, a spokesman for
PaineWebber said the costs will be significant for the entire industry, but no one has put a price on it.
``All the computer programs that run the stock order systems will have to change,' said Scott Abbey. ``Now all the orders are accepted in fractions. That affects a measurable number of all the (computer) systems at most securities firms.'
Further, he said, the volume of stock transactions and other financial data will increase anywhere from two to eight times with decimal pricing. That's because a big investor looking to buy a large block of a stock might have to execute dozens of trades over several 1-cent price points to get all the shares it wants, Abbey said.
History indicates he may be right. Trading volume rose 14 percent when the spread moved from 1/8 to 1/16, according to the Securities Industry Association.
``The industry is going to have to address the additional capacity to handle that,' Abbey said.
``All the computer programs that run the stock order systems will have to change. Now all the orders are accepted in fractions. That affects a measurable number of all the (computer) systems at most securities firms.'
SCOTT ABBEY
PAINEWEBBER INC. SPOKESMAN |
