How $0.05 Ticks on Small Caps Impact Traders

In late June the SEC told exchanges and FINRA to set up a program for select small cap stocks to trade in $0.05 intervals. The one year pilot program will include roughly 1,000 stocks with market capitalizations below $5 billion, average volume below one million shares traded each day, and price above $2.

If the pilot program is successful, widespread adoption of the tick rule may reverse the trend of ever-shrinking tick sizes. 1/8 dollars had been the standard tick size for 200 years before the New York Stock Exchange moved to 1/16 dollars in 1997 and a penny in 2001. One of the biggest challenges traders face today is high frequency traders sending bids and asks in sub penny increments that they do not have access to.

The purpose of the $0.05 spread is to level the playing field between retail traders and high frequency traders. By establishing prices at which trades can take place, the predatory sub penny trading advantage is taken away from high frequency traders.

The system currently allows computers to see orders that retail traders have on the market and step in front of them or lean on them with offers that individuals do not have access to make. This kind of trading takes away almost all market making ability and significantly increases the time horizon of trades.

The larger spreads and equality of order placing will reinstate some market making ability to individuals. Not only will traders be able to enter the same offers institutions have access to, but they will be able to collect more premium for providing liquidity with the larger spreads. This is because the wider spreads add risk to holding positions.

Another way this type of trading will benefit traders is by establishing additional price stability. With penny and sub penny trading, the order books stack up thinly at several different prices and one large order can clear out several levels of the book. With bids and asks stacking up more heavily at clearly defined prices, individuals will be able to more clearly see demand and supply of a stock. This will also make it easier for large players to enter and exit positions, further increasing volume.

The possibility of a permanent tick rule is hotly debated by traders. However, almost all can agree that legislative bodies taking action and collecting data is a positive.

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