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Increasing tick sizes is bad news for individual investors

By the beginning of this century, the old practice of listing stocks by fractions of a dollar seemed archaic in the modern, digital age. Fractions often had to be clumsily converted pennies, and investors suspected (rightly) that when rounding occurred, it was generally not done in their favor. Fractions also seemed to artificially inflate price spreads. A stock's price spread is the difference between the ask, which is what investors pay the market for a stock, and the bid, which is what the market pays investors. Price spreads are essential to the smooth operation of the market, but extremely high price spreads prevent liquidity and are unfair to investors.

To solve this problem, the markets converted to the use of decimals in 2001. As the SEC explained to the House of Representatives in 2000, “the overall benefits of decimal pricing are likely to be significant. Investors may benefit from lower transaction costs due to narrower spreads. Moreover, the markets will be easier to understand for the average investor, who is used to dealing in dollars and cents for every-day transactions.” In the stock market, each possible price point is referred to as a “tick,” so since the introduction of decimalization, there have been 100 ticks between each dollar for all stocks, all the time. Problem solved.

Thirteen years after decimalization, however, representatives of stock exchanges, among them NYSE Euronext, Nasdaq OMX and BATS Global Markets, are complaining about the “one size fits all” tick policy. Their first argument is that trading small and mid cap stocks in increments of one penny is bad for liquidity. Such stocks, they argue, don't attract the notice of investors, which makes it more difficult for small and mid-size companies to raise money in the market. Their second argument is that because tick sizes of one penny reduce commissions, analysts are unwilling to cover the stocks, and with less available research, market interest in these companies could fall even further.

Julian Close

Julian Close became a stockbroker in 1995. In his 20 years of market experience, he has seen all market conditions and written about every aspect of investing. Julian has also written extensively on corporate best practices and even written reports for the United Nations. He graduated from Davidson College in 1993 and received a Master of Arts in Teaching from Mary Baldwin College in 2011. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.