Decimalisation And Its Effects
When US equity markets switched from fractional pricing to decimals in 2001, minimum tick sizes shrank overnight — and quoted spreads, displayed size, and market-making economics all shrank with them.
Before 2001, US stocks traded in fractions of a dollar — an eighth, later a sixteenth, so the smallest possible price move was 6.25 cents. Decimalisation replaced that with pricing in cents, cutting the minimum tick from over 6 cents to 1 cent. It sounds like a bookkeeping change, but it rewired the economics of quoting a stock.
A smaller minimum tick lets spreads narrow, which is good for anyone paying the spread to trade, but it also shrinks the profit available to whoever posts the quote — so displayed size on the book fell even as spreads tightened.
Under fractional pricing, a market maker quoting the legally-required minimum spread of one tick was guaranteed at least 6.25 cents per round trip. Decimalisation let competitors undercut that quote by a single cent, and they did — average quoted spreads on liquid NYSE and Nasdaq names fell by more than half within months. Retail and institutional investors paying the spread benefited directly: transaction cost studies from the period estimate savings in the billions of dollars a year in aggregate.
The other side of that coin was quote depth. With a full tick's worth of profit no longer available to earn by being first in line, market makers had less incentive to display large size at the best price, so displayed depth thinned out. This pushed more trading toward smaller, more frequent orders and helped set the stage for the algorithmic and high-frequency trading that came to dominate execution afterward — decimalisation is often cited as the structural event that made sub-penny, high-speed quoting competition possible in the first place.
Further reading
- SEC, 'Decimalization of U.S. Equity Markets'