Decimal Trading Definition

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Decimal Trading Definition

What Is Decimal Trading?

Decimal trading is a method of quoting the price of a securities in a decimal format. The Securities and Exchange Commission (SEC) of the United States required that all stock exchanges in the United States transition from fractional to decimal quotations by April 9, 2001. Prior to 2001, market price quotations in the United States were based on a fractional quoting system with 1/16 dollar increments. Since decimalization, all stock quotations have been presented in decimal trading format.

Key Takeaways

  • The practice of quoting stock prices in decimal places is known as decimalization.
  • Since 2001, all U.S. stock exchanges have embraced decimal trading to improve orderly and efficient trade.
  • Prior to decimalization, the minimum spread was one-sixteenth of a dollar, or $0.0625. The minimal spread after decimalization is $0.01 for equities worth more than $1 and $0.0001 for stocks worth less than $1.
  • The sub-penny rule stipulates that the minimum price increments for equities above $1.00 be $0.01, whereas stocks under $1.00 may be quoted in $0.0001 increments.

Understanding Decimal Trading

Since 2001, all U.S. stock exchanges have embraced decimal trading to improve orderly and efficient trade. Decimalization refers to the use of decimals rather than fractions in pricing quotations. For investors, market makers, and all other sorts of market players, decimal quotations make prices more simply and quickly comprehensible. A decimal quotation is $5.06, but a fraction quote is $5 1/16.

A decimal quotation is made up of a bid price and an ask price. Retail traders and investors, market makers, and institutional traders may all place bids and requests.

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Bid-Ask Process

The spread is the difference between the highest bid and the lowest ask. In general, decimalization results in narrower spreads. Prior to decimalization, the minimum price movement expressed in a price quotation was one-sixteenth (1/16) of a dollar, which equaled $0.0625. For equities worth more than $1, the minimum price movement after decimalization is $0.01. As a result, stocks may now be traded with a $0.01 spread rather than a minimum $0.0625 (or 1/16) spread.

Tighter spreads are often preferred by most retail traders who wish to enter and exit deals without paying a high spread. Decimalization lowered spreads and hence the profit potential of traders and market makers aiming to “capture the spread” by frequently bidding and offering to grab modest gains. However, some traders still utilize this method today, mainly in automated or algorithmic trading.

The Securities and Exchange Commission issued Rule 612, popularly known as the Sub-Penny Rule, in 2005. Rule 612 specifies that the minimum price increment for equities worth more than $1.00 be $0.01, whereas stocks worth less than $1.00 may be quoted in $0.0001 increments.

Those with high daily volume are more likely to have smaller spreads than stocks with low volume. Spreads on higher-priced equities are more likely to be wider than on lower-priced companies. Volatile stocks have wider spreads than low volatility equities. The spread in any specific asset is determined by the volume (number of participants), volatility, and stock price.

Pips and Forex Quotes

Pips are one hundredth of a percent, one basis point, or $0.0001. Pips may be used to measure incremental changes in securities with prices less than $1.

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The foreign exchange market also has a decimal quotation technique that employs pips. For example, the EUR/USD may have a bid of 1.1257. Some forex brokers additionally provide fractional pip pricing to the fifth decimal point. The following statement, for example, might be further detailed as 1.12573. There are ten factional pips to one whole pip, signifying one-tenth the value of a complete pip. A pip’s value fluctuates depending on the currency pair being exchanged.

Decimal Price Quote vs. Fractional Quote

Assume a stock like General Electric Company (GE) has an average daily volume of more than 50 million shares with a bid price of $9.37 and an ask price of $9.38. Because to decimalization, this $0.01 spread is feasible. Because the stock is trading over $1, the spread cannot be less than $0.01, but it may be more. A wider spread may arise during periods of increased volatility, if volume falls dramatically over time, or if the price rises significantly.

Consider the identical situation prior to decimalization. The price quotation may have been $9 5/16 by $9 3/8 (or 6/16), resulting in a $0.0625 spread rather than the $0.01 spread shown above.

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