Decimalization is on the Way
by Matt Paolucci

We've been hearing Congress talk about the decimalization of stock prices for the last couple of years. Well, instead of talking the talk, Congress and the SEC may finally be walking the walk. At the beginning of this year, the Securities and Exchange Commission (SEC) said that it wanted the U.S. financial markets to display stock prices in decimals by July 3. Whether or not that date sticks is the subject of much argument. The original date for decimalization was slated for April 13. But if you're used to the breakneck pace at which our government operates, you could probably count on another delay. The point is that sometime this year, it's gonna happen, and when it does, it will be a glorious day for investors.

The decimalization of stock prices is the next step toward a more level investment playing field.

For one thing, the math will get easier. Instead of having to worry about eighths, sixteenths, thirty-secondths, and sixty- fourths, we will be starting out with nickel spreads, meaning five cents between the bid and ask price. A nickel is very close to a sixteenth, or "steenth", as they are sometimes called. A sixteenth is 6.25 cents, or $0.0625, and a nickel is, of course, $0.05. If the July 3 trial/experiment is successful, with the 30-50 basket of stocks in the test group, the next step would be to move to single-penny spreads.

So, why has it taken so long for decimalization to take hold? The same reason why we don't use kilometers and litres. We are stubborn, arrogant and unwilling-to-change Americans. Okay, I said it. One reason is that maintaining stock price spreads of 6.25 cents assures brokers and market makers of their cushy profits. The brokerage industry is probably not too concerned about a move to 5-cent spreads from 6.25 cents, although that is a 20 percent drop. However, if the 5-cent spread initiative works well, a move to single-penny increments would likely become imminent. At that point, spreads on stocks will have effectively been reduced by 83.3 percent. That is what makes brokers nervous.

Another reason for making the move toward decimalization is that there are more individual investors than ever before. The proliferation of daytrading is a prime example. If you think figuring out eighths and thitry-secondths was confusing for the thousands of investors and professionals up to this point, just imagine the confusion when the millions of teachers, housewives and mechanics-gone daytraders and other newbies decide that they want to try their hand at investing.

A third reason for the advocation of decimalization is that smaller spreads allow everyone to get in and out (buy and sell) without too much agonizing over price. Big spreads between the bid and ask can often times deter an investor from purchasing a particular security, and thus, missing out if the stock takes off to the upside.

There are also some disadvantages to decimalization. One would be that smaller spreads drive down the profits for the market makers. Who cares about them? Well, lower profits for them could mean more market makers out of business, thus, less competition and wider spreads. Market makers are the guys who provide the needed liquidity in the financial markets. Another disadvantage is that smaller spreads would inevitably render higher trading volumes. More volume translates into to more work for the electronic systems that run our markets. The risk of an electronic meltdown would increase.

All in all, decimalization is a good thing. The advantages definitely outweigh the disadvantages. Brokers may hate it, but it's not about the brokers. It's about investors, and moving toward a more level investment playing field for everyone.