Would Sub-Penny Trading Benefit Institutions?

A recent Forbes article featured some research and commentary we published last year on HFT and the Hidden Cost of Deep Liquidity. We received the following query from a buyside trader about one of our conclusions in the research note:

Q: Would sub-penny trading really benefit institutions?

A: Thanks for your question. I think this probably reflects many traders’ intuition that sub-penny pricing creates a difficult trading environment. Traders don’t want to see the real liquidity staying out at a $0.01 spread, with 100 shares always quoted $0.001 better than that “real” quote. I think the key here is to think about liquid, low-priced stocks separately from less liquid, higher-priced stocks. The reality is that in ultra-liquid stocks, a huge amount of volume is already trading inside the spread at midpoint, and off-exchange, where brokers have the ability to put up sub-penny prices when they internalize. This shows that the real market for these stocks is already tighter than the penny spread allowed by Reg NMS. By allowing exchanges to quote prices that are competitive with the real market, it should improve transparency and lead to narrower spreads and lower trading costs. Even if the spread doesn’t collapse all the way to $0.001 (which for some stocks it probably would) the algorithms that institutional traders use to manage most of their trading volume today are more than capable of engaging effectively in a world where the spread is a few ticks wide.

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