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human market makers rigged the public markets so that tradable instruments were quoted in fractions of a dollar, rather than in pennies, so they could surreptit

by minimax 13y ago

human market makers rigged the public markets so that tradable instruments were quoted in fractions of a dollar, rather than in pennies, so they could surreptitiously increase spreads. I don't think this is right. Erh, obviously U.S. equities traded in quarters and eights (and later sixteenths before decimalization), but to say that they were using a weird fractional system because they wanted to rip people off isn't documented anywhere in the literature. They could have moved to decimals and still kept the minimum price variation above a penny†, or they could have just added more fractions (32nds, 64ths, 128ths) that would have moved the minimum price variation into roughly the range you get by quoting in decimals. If you think quoting in 128ths sounds silly I won't argue with you, but it's something they do actually do for the US treasury futures contracts on the CME††. I suspect that they just used what worked. In a market of human traders, it's much easier to deal with large round numbers. I think that's why odd lots were treated specially too. E.g. It's a lot easier for humans to keep track of 5000 shares at 50 1/2 than in 100 small orders from 200 shares to 5 shares all priced between 50.40 and 50.60. As markets adopted technology, they naturally moved to a smaller minimum price variation (and eliminated the special treatment of odd lots) because computers don't have any problems dealing with an aggregate of small orders vs one big order. † They are actually talking about doing this for some small cap stocks later this year. http://online.wsj.com/news/articles/SB10001424052702304275304579396861123381346 http://online.wsj.com/news/articles/SB1000142405270230427530... †† ctrl-f "Quotation Practices" -- http://www.cmegroup.com/education/files/understanding-treasury-futures.pdf http://www.cmegroup.com/education/files/understanding-treasu...

tptacek 13y ago
https://www.sec.gov/litigation/investreport/nd21a-report.txt https://www.sec.gov/litigation/investreport/nd21a-report.txt Search "odd-eighth". Decimalization drastically reduced spreads. Scott Patterson suggested in _Dark Pools_ that it literally put many human market makers out of business; in other words: those human market makers were kept afloat by the gross inefficiency of quoting prices in 8ths and 16ths, an inefficiency that was taken out of the hides of investors.
- minimax 13y ago
  I was really just trying to make the points that 1) the minimum price variation of 1/8 of a dollar probably made sense at some point in the past (NYSE being started in the early 19th century) 2) sometimes it's more than just market makers who want larger tick sizes (consider this post from a managing partner at Andreesen Horowitz†) and 3) you can reduce the minimum price variation (the "tick size") without doing decimalization (i.e. smaller fractions) and vice versa -- you can set the minimum price variation at sizes larger than a penny even with decimalized quotations. † http://blog.pmarca.com/2013/03/26/unshackle-the-middle-class/ http://blog.pmarca.com/2013/03/26/unshackle-the-middle-class...
  - tptacek 13y ago
    I'm not sure what this comment means. You said, earlier: "but to say that they were using a weird fractional system because they wanted to rip people off isn't documented anywhere in the literature." I think I refuted that, effectively. Can you artificially inflate spreads without making inflated spreads the explicit law of the market by quoting in 1/8ths? Sure. Is that what happens? No.
    - minimax 13y ago
      I thought you were making a distinction between quoting in fractions of a dollar vs quoting in pennies. It isn't really material. If you quote in fractions but allow the minimum price variation to be 1/128th of a dollar you have a market that allows for tighter spreads than one in which the minimum price variation is a penny. There is nothing wrong with prices in fractions of a dollar. What matters is the minimum price variation a.k.a. the tick size.
      - tptacek 13y ago
        It is material, because the fractions of dollars we're talking about were bigger than 1/100th of a dollar. Clearly, they could have moved to sub-decimal fractions, but the point isn't "fractions" versus "decimals"; it's "human market makers fixed the fractions at 1/8ths and 1/16ths of a dollar to artificially increase the spread", versus "algorithmic trading competed the spread down below a penny". You implied that maybe humans had been using fractions because they were easier to deal with. No. They were using the fractions they were using in order to skim extra money off trades, and they fought tooth and nail to prevent competition from reducing spreads below 1/8ths --- in fact, if you read the link I showed you, it wasn't even 1/8ths; it was 1/4s!

by minimax 13y ago

tptacek 13y ago

https://www.sec.gov/litigation/investreport/nd21a-report.txt https://www.sec.gov/litigation/investreport/nd21a-report.txt Search "odd-eighth". Decimalization drastically reduced spreads. Scott Patterson suggested in _Dark Pools_ that it literally put many human market makers out of business; in other words: those human market makers were kept afloat by the gross inefficiency of quoting prices in 8ths and 16ths, an inefficiency that was taken out of the hides of investors.

minimax 13y ago
I was really just trying to make the points that 1) the minimum price variation of 1/8 of a dollar probably made sense at some point in the past (NYSE being started in the early 19th century) 2) sometimes it's more than just market makers who want larger tick sizes (consider this post from a managing partner at Andreesen Horowitz†) and 3) you can reduce the minimum price variation (the "tick size") without doing decimalization (i.e. smaller fractions) and vice versa -- you can set the minimum price variation at sizes larger than a penny even with decimalized quotations. † http://blog.pmarca.com/2013/03/26/unshackle-the-middle-class/ http://blog.pmarca.com/2013/03/26/unshackle-the-middle-class...
- tptacek 13y ago
  I'm not sure what this comment means. You said, earlier: "but to say that they were using a weird fractional system because they wanted to rip people off isn't documented anywhere in the literature." I think I refuted that, effectively. Can you artificially inflate spreads without making inflated spreads the explicit law of the market by quoting in 1/8ths? Sure. Is that what happens? No.
  - minimax 13y ago
    I thought you were making a distinction between quoting in fractions of a dollar vs quoting in pennies. It isn't really material. If you quote in fractions but allow the minimum price variation to be 1/128th of a dollar you have a market that allows for tighter spreads than one in which the minimum price variation is a penny. There is nothing wrong with prices in fractions of a dollar. What matters is the minimum price variation a.k.a. the tick size.
    - tptacek 13y ago
      It is material, because the fractions of dollars we're talking about were bigger than 1/100th of a dollar. Clearly, they could have moved to sub-decimal fractions, but the point isn't "fractions" versus "decimals"; it's "human market makers fixed the fractions at 1/8ths and 1/16ths of a dollar to artificially increase the spread", versus "algorithmic trading competed the spread down below a penny". You implied that maybe humans had been using fractions because they were easier to deal with. No. They were using the fractions they were using in order to skim extra money off trades, and they fought tooth and nail to prevent competition from reducing spreads below 1/8ths --- in fact, if you read the link I showed you, it wasn't even 1/8ths; it was 1/4s!