Sounds like you have two males sparring, especially if they are both bright red and the action takes place in mid-water. (Female pencilfish, with some exceptions, tend to be less colorful - more silver - and slightly plumper.) This sparring is actually a good indicator of health and well-being - the fish are at their best. I have never seen damage inflicted in any species I have kept. If your fish were spawning they would move in amongst plants or other suitable spawning substrates. (You don't mention the species, but my guess would be golden pencils by the red colour and behaviour, though there are other species with red on them. Anyway the comment would be pretty much the same for all. Golden pencils are one of the easiest pencils to breed.)
If you want to spawn them, and salvage some young, they will need to be separated from the community tank. They will spawn in very small tanks - I usually use 2 x 1 x 1 foot tanks divided into 3 or 4 sections, filled to about 3/4. I use acrylic wool mops as the spawning medium, but fine leaved living plants are fine. (Make sure there are no snails in them!) A bunch filling the spawning area to about 50%, leaving space for the fish to manoeuvre around and through is fine. (Some species, such as one-lined pencilfish, prefer to deposit their eggs on the under-side of broad leaves, so you could include some of these in case.)
To get good egg hatch rates the water should be soft, preferably at or below 50 ppm total hardness. pH around 7 is fine, say 6.5 to 7.5. I prefer to use a little peat extract (black water) with them and most other characins, but this is not essential. A temperature of around 25 to 26 degrees C (77 to 79 degrees F) would be fine. (Too much lower will reduce inclination to spawn, too much higher will impact on hatch rate.
They are avid egg eaters. I have frequently watched spawning fish eat their own eggs as they fall during spawning. In addition to this, they lay relatively very few eggs - usually in the tens per female per spawn, but this can vary depending on species, circumstances, and the age/size of the fish. So if you can, it is best to use a screen of some kind on the bottom for the eggs to fall through. I always spawn them in pairs (not groups) as non-spawners will eat eggs! Fertility, as with most characins, can be very variable.
Eggs hatch within 24 hours at about 25 C. Free-swimming in about 4 days, perhaps slightly longer. They are quite small as characins go. First food paramecium or other suitable infusoria, followed by newly hatched artemia when they are big enough. They are not the easiest to raise, but also not the most difficult.
I hope I haven't left anything out. If this has not put you off, good luck! I hope you are successful. Have you seen Nannostomus mortenthaleri? Unbelievably beautiful little fish!
