Decimalization

Decimalization is the process of converting stock price quotes from fractions to decimals. Before the 21st century, if you wanted to buy a share in the United States, its price would be listed in dollars and fractions, typically in increments of 1/8th or 1/16th. For example, a stock might be trading at $50 1/2. Decimalization, fully implemented in the U.S. markets by 2001, changed this system to the one we know today, where that same stock would be quoted as $50.50. This seemingly simple switch from a clunky, archaic system to a straightforward decimal format had profound effects on the market. It made prices easier for investors to understand, dramatically reduced trading costs by narrowing the bid-ask spread, and inadvertently paved the way for new trading technologies and strategies, forever changing the landscape of modern stock exchanges.

Why were stock prices quoted in fractions in the first place? The tradition dates back over 200 years to the Spanish Empire. The Spanish dollar, or “piece of eight,” was a widely accepted currency and could be physically broken into eight bits. This fractional system was adopted by the New York Stock Exchange (NYSE) when it was founded in 1792 and persisted for over two centuries. By the late 20th century, however, most of the world's exchanges had moved to decimals. The U.S. was one of the last major markets to make the switch. Prodded by the SEC (Securities and Exchange Commission), U.S. exchanges began the transition in 2000. The NYSE and NASDAQ completed their full conversion to decimal pricing in pennies ($0.01 increments) by April 2001, marking the end of an era.

This change was more than just a cosmetic update. It fundamentally altered the mechanics of trading, with both positive and negative consequences for investors.

The single most significant benefit of decimalization was the drastic reduction of the bid-ask spread. The spread is the difference between the highest price a buyer is willing to pay for a stock (the bid) and the lowest price a seller is willing to accept (the ask). This gap represents a direct cost to you, the investor, and a profit for market makers who facilitate trades.

• Before Decimalization: The minimum price increment, or tick size, was typically 1/16th of a dollar, which is $0.0625. If you wanted to buy a stock, you might have to pay $20 1/16 ($20.0625) even if the seller's true value was closer to $20.01. That $0.0625 spread was the smallest possible gap.
• After Decimalization: The minimum tick size became one cent ($0.01). Now, the spread could shrink to a single penny. That seemingly small change reduced spreads by over 80% on average, meaning buying and selling stocks became significantly cheaper for everyone.

For the average person, decimal prices are simply more intuitive. It is far easier to compare $15.25 and $15.40 than it is to compare $15 1/4 and $15 3/8. This improved transparency made the market more accessible and understandable. Furthermore, the smaller tick size fostered greater competition among market makers, who now had to compete by the penny, not by the “sixteenth,” to win business. This competition helped keep spreads tight and prices efficient.

While decimalization lowered costs, it also had a disruptive effect on market structure, leading to a new set of challenges.

• === The Rise of High-Frequency Trading ===

The one-cent spread, while beneficial for retail investors, created a perfect environment for high-frequency trading (HFT). HFT firms use powerful computers and complex algorithms to execute millions of orders in fractions of a second, aiming to profit from tiny, fleeting price discrepancies. The penny tick size provided just enough of a potential profit margin for these strategies to flourish.

• === Penny-Jumping ===

This new environment enabled a controversial practice sometimes called “penny-jumping,” a form of front-running. An HFT algorithm can detect a large institutional order to buy a stock. The algorithm can then instantly place its own buy order just one cent higher than the existing best bid, forcing the large investor to pay a slightly higher price. While just a penny, these costs can add up significantly for large funds trying to build a position without alerting the market.

So, was decimalization a good thing? For the most part, yes.

• For the ordinary value investor making occasional trades, the benefits are clear. Your transaction costs are lower, and the prices you see are easier to understand.
• The rise of HFT and the complexities of modern market structure are real concerns, particularly for large-scale investors. The market is now faster and more algorithm-driven than ever before.

Ultimately, as a value investor, your primary focus remains unchanged. While it's wise to understand the plumbing of the market, don't get lost in the noise of microsecond trading. Your greatest advantage comes from a patient, long-term perspective focused on analyzing businesses and buying them at prices that offer a significant margin of safety. The fractions may be gone, but the fundamental principles of sound investing endure.