Yesterday's first tiny move to decimal pricing on the stock exchanges was mandated by Congress and ordered by the Securities and Exchange Commission. The switchover will proceed in stages and should be complete by April of next year. The monetary benefits of this change to Foolish Four investors is negligible, since the whole purpose of a mechanical investing approach is not to obsess about the minute-to-minute moves in a stock's price. But, the more rational decimal system will benefit everyone in the long run.
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There's a word that doesn't roll easily off your tongue! More importantly, it's coming to an exchange near you.
Decimalization is the process of changing stock prices from fractions to decimals. You've probably wondered why stock prices were quoted in fractions of a dollar instead of cents like everything else. Anything to obscure and obfuscate! Actually the problem is more one of fear of change. Stocks were originally traded using the Spanish real, a silver coin of international trade that used the logical system of dividing by two whenever smaller denominations were needed. So there were half reals, quarter reals, and eighth reals. (Remember "pieces of eight"?)
Although the rest of the world has managed to move beyond pirate accounting, the pirates of Wall Street clung to the old ways even when the U.S. dollar became the mandated medium of exchange. Instead of using the far more convenient "cents" that broke the dollar into 100 pieces, they continued to trade in minimum units of 1/8 dollar -- probably because the market makers in the olden days realized, as those today surely do, that a larger minimum unit would put more pennies into their pockets. (By the way, the one-eighth of a dollar unit was known colloquially as a "bit." Two bits, four bits, six bits, a dollar -- all for Decimalization stand up and holler! Yea!)
It took a Congressional mandate and direct order by the Securities and Exchange Commission to get the markets to finally make the move.
Phase 1 began yesterday, as seven securities on the New York Stock Exchange moved from slashes to periods. They were Anadarko Petroleum Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: APC)") else Response.Write("(NYSE: APC)") end if %>, FedEx Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FDX)") else Response.Write("(NYSE: FDX)") end if %>, Forest City Enterprises Inc. Class A and B <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FCE.A)") else Response.Write("(NYSE: FCE.A)") end if %> and <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FCE.B)") else Response.Write("(NYSE: FCE.B)") end if %>, Gateway Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GTW)") else Response.Write("(NYSE: GTW)") end if %>, Hughes Supply Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HUG)") else Response.Write("(NYSE: HUG)") end if %>, and MSC.Software Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MNS)") else Response.Write("(NYSE: MNS)") end if %>. Since they're all handled by one specialist workstation, it's believed the changeover would be easier. Seven companies on the American Stock Exchange also began trading in decimals yesterday.
Phase 2 on the NYSE is slated to begin on September 25 and will include an additional 52 companies. The next group of stocks have been chosen based on their location throughout the trading floor, to give traders more experience with decimal pricing and with shouting decimal orders at the same level of decibels.
The National Association of Securities Dealers (NASD) believes that the change will increase investor interest and, as a result, increase market volume. However, the Nasdaq (originally NASD's Automated Quote system, which has become an entity in its own right) has blamed increased volume for its inability to change to decimals as quickly as the SEC would have liked. Ultimately, however, Nasdaq will surrender its fractions and join its decimaled friends by the April 2001 deadline. Ah... the farewell tour for the numerator and denominator.
The changes have various benefits for investors. First and foremost, the whole darn pricing situation will be simplified. This is in line with the SEC's efforts to segue into "plain English" wording for prospectuses and filings. While an SEC filing will never be as easy to read as Fun With Dick and Jane, the plain English trend has enabled investors to more easily understand the language of a prospectus, which used to leave investors drowning in the void of corporate verbiage, scratching their heads in stupefaction, or pulling out their hair in an effort to comprehend the barely comprehensible.
Decimal numbers are far easier to understand and manipulate than fractions. While professional traders gripe that they will be confused under the new system, the vast majority of investors will find it much easier to figure out exactly what they are paying. How many of us know immediately that $25 5/16 is $25.3125? Or realize immediately that 5/16 is less than 3/8?
U.S. markets will now be more competitive with foreign exchanges, which have been using the decimal system for quite some time. There have always been slight disparities in price when foreign securities were trading in decimals in their home markets and fractions on the U.S. exchanges. Foreign investors must have found our system embarrassingly outmoded.
Investors will also benefit from a narrowing of the spread that they pay when purchasing a stock. (The spread is the difference between what the market maker or specialist pays for a stock and what he sells it for.)
A few years ago, the pieces of eight were sliced one more time to allow stocks to trade in sixteenths. That saved investors billions by cutting the minimum spread in half. Now, most stocks trade in increments of 1/16, or 6.25 cents. If a market maker buys a stock at, say, $20 5/16, he must mark it up by at least $0.0625, to $20 3/8, to make a profit. (Some stocks are carved up into 1/32 and 1/64 slices, but those are usually lower-priced stocks, and definitely not Fool Four stocks.)
The switch to decimals means that market makers will have even more latitude when setting spreads. For heavily traded stocks, the spread should drop to $0.05 immediately and could conceivably go as low as $0.01. Stocks with lower trading volume will continue to have higher spreads, but competition between market makers should result in those spreads being shaved by a few pennies at least.
Although frequent traders are thrilled with the prospect of smaller spreads, for Foolish Four investors the advantages of lower spreads are somewhat moot, since the whole purpose of a mechanical approach is not to obsess about the minute-to-minute gyrations of the market. When you commit to the Foolish Four technique, it's not necessary to get the "best" price at any given moment. Since we're holding these four companies for a year and a day, a penny here or a penny there will not be particularly relevant. For long-term buy-and-hold investors, the monetary significance becomes further reduced.
But, anyone who has ever sat down and tried to figure out how many shares of GM they were supposed to buy when it was selling at $62 9/16 and they wanted to invest $2000 will definitely appreciate the simplicity of decimal pricing!