Investors may soon see their favorite stocks quoted in half-penny increments.
The U.S. Securities and Exchange Commission will vote Wednesday to change the minimum pricing increment for many large-cap stocks, likely to allow for pricing increments of a half-cent. The agency rolled out this proposed rule in late 2022.
The measure would likely affect the pricing of most of the largest stocks, including most in the S&P 500. It may also affect the pricing of some highly liquid Exchange Traded Funds (ETFs).
Currently, the minimum pricing increment — or tick size — for most stocks is one cent.
Quote sizes have been coming down for a long time
Before the mid-1990s, the stock brokerage business was very profitable.
Since the 1800s, the smallest increment that a stock traded at was an eighth of a dollar (12.5 cents). A broker might have a bid — a price at which they would be willing to buy — of $20.00 for XYZ stock, and an ask — that is, a price at which they would be willing to sell — of $20.125. That’s an eighth of a dollar higher.
That turned out to be a very lucrative business.
This all began to change in the 1990s. In 1997, the minimum tick size went from an eighth of a dollar to a sixteenth, or 6.25 cents. This dropped to a penny in 2001.
These reductions in tick size had a profound effect on the brokerage business: It made stock trading far less profitable, but it provided big savings to buyers and sellers of stocks. Reducing the tick size also improved market liquidity.
Why do we need half-penny tick sizes?
As the volume of trading in the largest stocks has expanded, the trading community has debated about whether tick sizes should be reduced further. For starters, certain highly liquid stocks are “tick constrained,” meaning they could easily trade if the tick size were reduced further. There have been discussions about adding tick sizes of a tenth of a cent or a fifth of a cent, as well as a half cent.
Why reduce the tick size further? For the same reason minimum pricing increments were reduced decades earlier: This would reduce trading costs.
Most in the trading industry feel the SEC will settle on a half-cent increment because trading in increments of one-tenth of a penny creates too many price points.
Investors who dread the idea of their favorite stocks being quoted in half-penny increments will likely have some time to get used to it.
Most market participants told me any change would likely take a year or more to implement, as it would require changes in the systems that display quotations.