There are many terms related to trading in the financial markets that investors should know about. While it’s certainly possible to trade without getting to know every detail associated with the assets you’re buying or selling, it’s not really a prudent idea to remain ignorant about the essential jargon related to the markets. Among the important concepts that you should get to know, tick size is something that’s often overlooked.
Understanding the tick size meaning and getting to know what it is by looking at some tick size examples can help you make better investment choices. So, without further ado, let’s look at what tick size is all about.
What is tick size?
In the broad sense, tick size is the smallest amount of fluctuation possible in the price of an asset. The tick size or the tick value is worth a specific amount of money. And it varies from one kind of asset to another. Tick size can also be defined as the minimum movement in the prices of a trading asset. The price can move upward or down on the exchange, but it always moves in multiples of the tick size.
The origin of tick size
Before the advent of electronic trading, when stocks were traded on the floor of the NYSE, traders would buy and sell stocks in person. Back then, the prices of stocks would fluctuate by 1/8th or 1/16th of a dollar. This means they moved up or down by $0.125 or $0.0625 respectively per share. Now, however, stock prices can fluctuate even by a few cents.
But earlier, traders would try to make a gain from the minor differences in the stock prices. By knowing what the smallest amount that a stock could move by was, traders could try and scalp between the price changes. So, tick size is a concept that goes way back, and since ages, people trading on stock exchanges and other exchanges have tried to take advantage as the price of the assets moved across by the tick size.
Why does the tick size matter?
Tick size is a universal concept that exists for all assets – stocks, options, futures, and more. If you do not know the tick size of the futures contract that you’re trading, for instance, you may unknowingly take a trading position that is too high or too low with regard to your trading objective. This is because the price of each futures contract fluctuates by a different amount with respect to other futures contracts.
For example, during a specific trading period, one futures contract may move by 200 ticks while another may move by 50 ticks. Say both these futures are trading at Rs. 40 and Rs. 42 respectively. Without knowing the tick size, you may think that these two assets, trading at similar values, may move by similar fluctuations. But when you become aware of the tick size, you’ll see that one asset moves by more than the other. This factor influences how you formulate your trading decisions.
Tick size example
To understand the practical impact of this concept, a tick size example may be of great help. Let’s assume that a stock has a tick size of Rs. 0.10. And say it was last trading at Rs. 100. So, based on this, the ideal bid prices for the stock may be Rs. 99.90, Rs. 99.80, Rs. 99.70, and so on. A bid price of say Rs. 99.84 would be inconsistent and invalid, because it does not meet the tick size for that stock.
Similarly, the offer prices also will be determined by the tick size. These values would be Rs. 100.10, Rs. 100.20, Rs. 100.30, and so on. If there are no bids at a particular level, then the price coming in at the next point when you move by the tick size would be considered. For instance, if there are no bids at Rs. 99.90, the next bid price of Rs. 99.80 will become the best bid price. This is also true for the offer price.
So, you see from this tick size example how the value of the tick can help you make the right bid or offer on an exchange. This is why it’s important to keep an eye out on this metric. Otherwise, you may place imprudent bids or offers, and this could lead to poor trading outcomes. So, the next time you trade any asset on the exchange or otherwise, make sure you’ve accounted for the tick size in your trading decision.