The impact of the Securities and Exchange Commission on the world of day trading takes time to understand in full. Beyond day trading, there is a vast web of regulatory infrastructure that would make any government worker cry tears of joy.
But one of the most recent SEC innovations has a huge impact on the world of day trading: the tick size pilot program. This needs to be laid out and explained in layman’s terms first. Back in the heady days before April, 9th 2001, all stocks were traded in fractions of ⅛ or 1/16. Essentially, each dollar was split in 8 increments for stocks trading at 1/8, with 12.5 cents per spread or split into 16 increments, at 6.25 cents per spread. There were only so many price points that traders could use to place orders within one dollar.
Then, that fateful day of April 9, 2001, the market turned over to decimalization. Which meant that traders could now place orders of $435.26 cents or $56.72 cents. Basically, jumping the amount of price points that traders could use.
The US was last stock market in the developed world to make the leap toward decimalization. The idea was that foreign investors would be more attracted to Wall Street because it would be easier to understand. And that volume increase would bring about more liquidity in the market and investors would be happy.
But narrowing the spreads on the trades meant less profits for market makers, or, in other words, big investment banks that would be inclined to make big moves on certain sectors and be ready for traders that want to buy and sell. Market makers need to be able to have shares on the bid and the ask, which means that they make their money on the spread. Less market makers actually meant less capital and less liquidity.
What that means today for day traders is the SEC is testing out a new tick size of 5 cents. A tick pilot program began in 2016 that included 1200 small-cap stocks. One of goals of the program is that volatility in small cap stocks has decreased. Which is not great news for day traders, who capitalize on daily volatility in small to mid-sized stocks.
Warrior Trading, a day trading education site, has more info on this program and other issues related to day trading. Find Warrior Trading on Twitter and you can get the scoop on how all of this affects day traders.