4 Nov

Tick Size Pilot Program, Gift Or A Curse?


For a full list of stocks affected by the tick rule, click here

I’ve got a quick question for you. How do you like the Tick Size Pilot Program so far? Now, I’ll share with you my thoughts on it shortly…first, let me explain it to those who are not yet familiar with it.

So it’s basically a test conducted by the regulators to see if messing with the tick size of small cap stocks is at all going to affect volatility, liquidity, and overall trading. This program started on October 3, 2016. It consists of a control group and three test groups (400 small cap stocks per test group).

The control group will trade like it normally would. However, the first test group will be quoted a nickel wide. For example, if XYZ stock is part of this group you might see a bid/ask spread like 0.05 – 0.10. Say goodbye to penny wide markets to some of your favorite stocks to trade, if they’re part of this group.

The second group will also be quoted a nickel wide, but allow for exemptions on some special cases. The third group will follow the same structure as group two; however, there are exemptions for block trades. In addition, this group is also subject to something called the trade-at rule. Basically it’s an attempt to limit off exchange transactions.

Oh, and by the way, this genius idea was developed not by an NYU Tandon School of Engineering graduate… nope. This was the brainchild of a politician out of Wisconsin.

Why you might ask? The idea is that because these small cap companies are going to be trading a nickel wide now, they’ll be able to increase their value quicker and, in return, create more jobs for the future. In addition, market makers will be more interested in getting involved, which would then lead to banks covering these stocks. Since there are market makers around, they’ll eventually keep everything orderly and less volatile for us.

Now, if you’re shaking your head trying to figure out how that logic makes sense, I’m right there with you. Bank of America has a market cap north of 165 billion dollars and it trades in penny increments. I don’t get how making spreads wider is a positive for anyone else except the market makers…

When things get nutty, the market makers are ghost and markets get so wide you can drive a truck thru them. One only needs to go back to August of 2015 and that epic flash crash. But reality, we have mini-flash crashes in individual stocks every day. The point is, making spreads wider is not going to help, but potentially make things worse when the market makers back off.

We went from trading in fractions to penny wide markets, and now we’re going backwards to nickel wide spreads.

As traders, that means we have to make a lot more calculations in terms of position sizing and risk management. A couple of down ticks and you could be down 0.25 to 0.50 on a long position in no time. Some traders will say screw it and not even try to trade stocks that fall in these groups. Consequently, this will create the opposite of their intended goal of improving liquidity.

Shocker, the politicians get it wrong again.

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