What Is Tape Shredding?
In finance, the term "tape shredding" refers to the practice of executing a single purchase or sale order using a series of smaller transactions. The term originates from before the adoption of fully computerized trading platforms when brokers used to receive their trade orders on printed composite tape, also known as ticker tape.
- Tape shredding is the practice of breaking up large orders into several smaller orders.
- It was common among human brokers prior to the computerization of most trade execution activities when orders were printed on tape.
- In the past, tape shredding could be used for both benign and nefarious purposes. Nefarious reasons included brokers aiming to increase their commissions by executing more orders.
- The primary reason for shredding tape was to make it easier to fill large orders quickly.
- Tape shredding is legal though regulatory authorities do keep an eye on such practices to ensure they are being used appropriately.
- Ticker tape machines still lend use to the terms "ticker symbol" and "ticker tape" when referring to stocks and scrolling stock information, respectively.
Understanding Tape Shredding
Tape shredding is the practice of dividing a single purchase or sale order into a series of smaller orders. Historically, brokers would do so when they believed that it would allow them to fill the entire order more quickly. Today, however, this practice has mostly disappeared as the vast majority of trades are now executed by computers.
Although tape shredding by human brokers is now a rarity, the underlying concept of tape shredding continues to be widely used. In fact, computers now routinely break up electronic trade orders into several smaller transactions in order to obtain the most efficient possible execution for the market participants involved.
While computerized tape shredding is viewed as a logical and uncontroversial trade execution strategy, unscrupulous human brokers sometimes used the technique to benefit themselves at the expense of their clients. It is not seen as an illegal activity but is closely monitored by regulatory authorities.
For example, in 2006, the National Stock Exchange (NSE) proposed a rule changing an aspect of the prohibition of tape shredding to the Securities and Exchange Commission (SEC), which was accepted by the SEC.
Because brokers are often compensated for each order they fill, unethical brokers would sometimes split up large orders into several smaller orders, simply for the sake of generating additional commissions. Because the computerized trading platforms function for the benefit of all market participants rather than specific clients, this type of activity rarely, if ever, occurs today.
The term "tape shredding" should not be confused with the practice of shredding documents, whether that be for practical purposes or to destroy evidence of criminal wrongdoing.
Before electronic trade execution became commonplace, human brokers would receive their clients' orders on physical machines that would print those orders on composite tape. These records were nicknamed "ticker tape" because of the ticking sound made by the machines that printed them.
Although these machines are no longer used, their influence is still seen in various terms, such as "tape shredding," "ticker tape," and "ticker symbol." For instance, the term "ticker tape" is used to refer to the horizontally scrolling band of stock prices that are often featured in stock exchanges and in financial media. Similarly, the term "ticker symbol" is still used to refer to the codes denoting different stocks, such as "FB" for Facebook (FB) or "TSLA" for Tesla (TSLA).
Example of Tape Shredding
Assume Hedge Fund ABC has assets under management (AUM) of $2 billion and is in the position to buy a large order of whatever stock it believes will be a good investment. It decides to purchase 300,000 shares of Company XYZ. Because 300,00 shares of Company XYZ is a large percentage of its total shares outstanding and would cause a significant shift in the stock price, Hedge Fund ABC decides to tell its broker to "shred the tape."
Per Hedge Fund ABC's instructions, its broker purchases shares of Company XYZ in 15,000 share increments over the course of a week. This fulfills Hedge Fund ABC's orders and minimally impacts the price movement of Company XYZ's stock. The broker also receives a commission on each 15,000 share order they transact.