Trader Talk

Stock Market Trading: Should Stocks Trade at a Nickel Spread?

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Tomorrow the SEC will hold a hearing on whether they should start a pilot project to let some stocks trade in increments of other than a penny.

Decimalization (trading in penny increments) has brought several benefits to trading--specifically, it's made the cost of doing most trades much lower--but it has also brought problems.

One of them is that the brokerage business is not nearly as profitable as it used to be. One consequence of that is that many small and start-up companies don't get any coverage from analysts, and many of these small companies die from neglect.

And they're right: the number of stocks being covered by analysts has been going down, and you can trace a lot of that back to decimalization. Decimalization made it less profitable--unprofitable, in some cases--to trade stocks. Analysts are paid with these "soft dollars" from trading--if there are no orders for the stock, it is not going to get any coverage.

The SEC will hear from several market structure experts. It's likely that one of the recommendations will be a pilot program to see if trading in wider increments (like a nickel) might improve the economics enough to increase research coverage.

My sense is that there may be a consensus for a very limited pilot program…likely with thinly traded stocks that have low market capitalizations…to test trading in increments other than a penny, likely a nickel.

Down the road, companies may even be able to choose what kind of spread they trade at...a penny, three cents, a nickel. But that is way down the road and only if a pilot program is implemented and deemed to be successful.

My take: I am all in favor of a small, limited pilot program to see if thinly traded stocks might be able to trade in increments other than a penny. But given the many technological failures (BATS, Knight, etc) we've had recently, we need to figure out if the markets can technologically handle this.

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