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FLASHBACK FRIDAY: Decimals Cut Into Dealers' Profits

Traders Magazine Online News, September 22, 2017

John D'Antona Jr.

One-eighth. A sixteenth. Three quarters.

Remember when stocks were quoted and traded in fractions? “Five hundred shares trading up an eighth, what do you want to do?”

Just as the fallout from any Millennium Bug or residual Y2K concerns was exiting US financial firms’ collective radar, Wall Street was staring at a new paradigm in trading -  moving from fractions to decimals. The move had revolutionary implications – from testing Wall Street’s technology to the ability of firms to make a living. Decimalization had the potential to change the trading landscape for both buy- and sell-side firms as well as retail mom and pop traders.

One retired buy-side trader who spoke with Traders Magazine remembers the time well.

“When we couldn’t quote in fractions or trade that way anymore, it really killed us,” the former buy-side trader said. “And it didn’t just kill us but the entire business. It took the markup/markdown business where you are making a 1/16  or an 1/8 down to pennies. Commissions eroded into single pennies.”

It became a marketplace where only the strong could survive. Brokers closed. Firms shrunk in size. And while the largest firms managed to survive and rely on either non-equity trading revenue streams or other businesses such as investment banking.

Another former trader added that he remembers cash commissions for full-service broking as being in the 5 to 6 cents range and the 2 cent range for what then was considered electronic trading. In comparison, now full-service service costs 2 to 3 cents and electronic trade execution is around 1 cent or less.

“Dealers are still making money as they are still in business,” he said. “But some firms definitely went under. We had commission rates going down and trading volumes going up. The smaller firms got wiped out. Just look at the modern trading floor and check out the names and posts – see who is left.”

Now, he added, as commission rates are still down and volume has slowed too. How are the brokers paying their bills, he asked? “You know that decimals have been really hard on them.”

Another byproduct of decimals was the erosion of the block trade, a third trader commented. Gone are publicly quoted blocks of multiple-hundred shares that broker could charge extra for executing. The old adage, “You want size…you have to reach” went the way of the Edsel.

“It took the whole concept of getting liquidity at a price away,” he said. “Instead of having huge blocks at every 1/8 on an exchange, you now have everything in pennies and hidden off board or in dark pools. There is no more price discovery out in the open.”

And that sounded the death knell for the exchange open trading floor to many. As Traders Magazine observed firsthand on a visit to an exchange, gone is the noise of floor traders jostling for shares and picking up phones. No more order tickets littering the floor. At one point, the hum of the air conditioning system could be heard.

So what has decimalization brought?

“It’s cheaper than hell to get a trade done,” said one veteran trader. “Mom and pop can get a penny spread but institutions have to go through hoops for pennies. It hasn’t helped the industry in terms of profitability.”


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