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Recently, the SEC actually passed a rule forbidding people from trading in sub-pennies. This is absurd- it would be as if the government decided that car dealers could only advertise, negotiate, and sell cars at prices that were round $1,000 increments. See a car you like for $12,000, but know you could get it for $11,500? Tough luck, you'd only be allowed to buy it for $11,000 or $12,000. So even if the car dealer was willing to sell it for $11,500 you'd have to pay $12,000. Sound silly? Yep.
Here is my letter talking about why this is bad.
My letter explaining why bid-tick and down-tick tests on short sales are un-American.
Q:
hey dumbshit,
The sub-penny rule applies to things that would be priced for increments less than one PENNY, not $1000.00. Your example of wanting to buy a car for $11,500.00 instead of $12,000.00, but it not being possible because you seem to think that the FIVE HUNDRED DOLLARS difference is less than ONE CENT. A better example would be want to buy a piece of candy for 11.5 cents, instead of 12 cents or 11 cents.Ass.
A:
If you were only forced to use whole pennies on the total transaction price, you’d be right. Unfortunately, the penny increment rule applies to the price of *each share* of a stock transaction, not the transaction as a whole. This makes a big difference.
So, for example, if you wanted to buy 100,000 shares of a stock, then a difference of $0.005 per share would mean a total difference of $500.00 for the transaction. Stocks routinely trade in transaction quantities of 100,000 shares and more.
Even if you are only buying 1,000 shares of a stock, the increment rule could affect the cost of your total transaction by up to $9.99. Considering that many people switch brokerage firms to get a commission that might be $4.95 lower than what they were paying, $9.99 appears to be a financially significant amount of money on trades of this scale for many people.
To make things worse, buying a car is usually a single transaction. Stocks are often bought and sold multiple times and the increment loss applies cumulatively to each and every trade. That means that for each 1,000 shares of a stock that you bought and then sold some time later, on average you’d have lost about $10 on the round trip compared to what your net proceeds would have been with finer than penny increments. Over time this can add up to really significant amounts of money, even (especially?) for casual investors. For a typical investor who does a couple of 1,000 share trades a month, the compounded losses over the course of 20 years are thousands of dollars. Those sub pennies really add up.
Q:
Don't all the sub pennies wash out in the end? Sure I'll loose a couple bucks on one trade, make it back on the next trade.
A:
Trading is a zero sum game - for every buyer there is a seller and a given mispricing will always benefit one party exactly as much as it hurts the other. The problem is that the distribution of increment-caused mispricing errors is not random.
Most casual investors in the US tend to buy stocks at the ASK and sell stocks at the BID. Since increment pricing errors will always have the effect of lowering the bid and raising the ask, investors disproportionably tend to get the short end of the trade, with brokerage firms and professional traders tending to be beneficiaries.
If you are an investor, this is just one more reason not to use market orders to trade. Limit orders are no panacea, but at least there are fewer ways for you to be taken advantage of if you use a limit order than a market order.