By James Langton

(April 4 – 17:00 ET) – It’s not often that the Toronto Stock Exchange receives a pat on the back, but one research firm says that U.S. markets should follow the TSE’s approach to decimalization.

A new report from Cambridge, Mass.-based Forrester Research Inc. says that the decimalization of the New York Stock Exchange and Nasdaq, “won’t reduce investor trading costs as promised. Instead, it will enable further front running by specialists.”

The NYSE began quoting stocks in decimals in January and Nasdaq plans to complete its conversion to decimals in April. The aim of decimalization is to reduce trading costs for investors with lower spreads, and to make the U.S. markets competitive with international markets. But Forrester argues that, “across-the-board decimalization — with one-cent pricing increments for all types of stocks — will raise, not lower, trading costs for institutional investors”.

The report argues that decimalization lowers the price and the risk of front running, which in turn pushes institutional investors away from specialists, at least for large orders. “But these actions make it more difficult for investors to understand supply and demand and to receive prices that reflect the true supply and demand for a stock. As trade sizes get smaller and smaller, the negative price impact of large trades by institutional investors will continue to increase,” says Forrester.

To combat this, Forrester recommends that, among other things, “Investors should lobby the Securities and Exchange Commission for a tiered pricing scheme like the TSE — with quoting and trading increments that increase with the price of the stock. As trading increments increase, it will become more expensive and risky for specialists and market makers to front run.”

Short of that change, Forrester recommends that investors trade listed stocks on independent electronic communication networks, and execute large trades on electronic crossing networks, such as ITG’s Posit.