NASDAQ Traders "Pinched" By Pennies

May 29, 2001 ( -NASDAQ traders are feeling the "pinch" of the exchange's shift to decimalized trading --and they are pushing a new commission-based approach with institutional investors as an alternative.

The “decimalization” of stock trading, mandated by the Securities and Exchange Commission (SEC) provides for stock quotes in dollars and cents rather than in fractions of a dollar (e.g. 1/8, 1/16). Decimal-based trading was fully implemented on NASDAQ on April 9  , and on the NYSE in January .

According to the Wall Street Journal, traders say the proposed commission system would address the revenue drain that decimals could cause them, while at the same time clearly identifying commission costs for investors, rather than burying costs as the previous system did.

NASDAQ and SEC officials are said to be receptive to the possible change.

Spread-ing “Out”

Wall Street trading firms previously made money by trading NASDAQ stocks for institutional clients on a “net basis” ? where traders kept part of the “spread” – the gap between the best buy- and sell-order prices. According to the article, prior to the decimal conversion, most trades involved a minimum spread size of 1/16, or six cents. The trader’s fee, imbedded in that spread, was typically three cents, according to the report.

Since the conversion to decimals, spread sizes have shrunk to three cents or, in some cases, one cent or two cents ? cutting trader commission in half ? or more.

Switching to an agency-based system with a fixed commission fee is viewed by many as a win-win situation, setting traders up as a true middleman between buyer/seller. In the traditional practice, “market maker” traders risk their own money to make buy and sell orders match.

Brokers that operate on the New York Stock Exchange (NYSE) have been largely unaffected by the change, since those brokers have always operated on a fixed-commission basis.

What Goes Around

Commissions aren’t the only problem areas for traders, however. Reduced fees have also crimped the current system where trading firms pay fees to brokerage firms in exchange for sending trading firms orders to be executed.

Earlier this year the New York Stock Exchange (NYSE) said it was planning to ask the SEC to consider allowing trades in nickel increments, rather than pennies ( NYSE Pushing for Nickelization ). That request was an attempt to head off traders who were “stepping in front” of large institutional trades.

The NYSE and NASDAQ have until November to propose decimal-trading related issues and recommendations to the SEC.

– Nevin Adams

Also see Money Managers Unhappy With Decimalization