What is Tick Size

What do you think is a better investment option – trading or investing? While both options promise to make you money, nowadays, trading is stealing the limelight.

At its core, trading focuses on short-term movements in the stock market. One of the trading strategies gaining popularity is Tick Trading. It is a high-risk & high-reward strategy that depends on making split seconds decisions. In this blog post, we'll explore the detrimental aspect of Tick Trading— Tick Size.

Origin of Tick Size

The origins of tick size go back to the early days of stock trading when transactions were executed in physical locations called trading pits. Each pit had its own rules and conventions, one of which was the minimum price change that could be made. This minimum price change was known as the tick size.

Today, tick sizes are typically much smaller than in the past due to the advent of electronic trading. Therefore, the modern narrative narrates that the name “tick” comes from the fact that each trade is usually only worth a slight change in price, known as a "tick."

There are many different stories of the origin of tick size, but its core purpose remains the same to prevent price manipulation and provide more liquidity. It is an integral part of the market structure. Regardless of the security being traded, the tick size provides an important measure of price stability and helps to ensure fair and orderly markets.

What is tick trading?

Tick trading is a type of day trading that involves making trades in very short timeframes, typically just a few seconds or minutes. It consists in taking advantage of small price movements to make a profit.

Dependency of tick trading on tick size

For a tick trade to occur, there must be a minimum change in price equal to the tick size. If the tick size is too large, finding a counterparty willing to trade at that price level may be challenging. As a result, the tick's size directly impacts the market's liquidity and the traders' ability to find willing counterparties. Tick size also affects the cost of trading, as larger ticks incur more significant transaction costs. Thus, when choosing a tick size for a particular security, it is essential to strike a balance between liquidity and cost.

Several seasoned day traders and other short-term traders make quick profits from these small price movements. For more accurate results, Tick traders use special software that allows them to place trades very quickly. They often trade on multiple exchanges to take advantage of minor price differences.

Tick size meaning

The tick size is the smallest increment/reduction of price movement possible. For example, if a stock has a tick size of Rs.0.5, it can only move in increments/decrements of Rs.0.5- it can't move any less than that.

What is Tick size?

“Tick size is the smallest increment/reduction of price movement a security can make.”

Why Does Tick Size Matter?

In tick trading, the size of a tick, or the minimum price movement of a security, is an essential factor in trading. Moreover, a tick size directly impacts the liquidity of security and, ultimately, the price at which an investor can buy or sell shares. As a result, a tick size is essential because it helps ensure investors can trade stocks at a fair price.

Characteristics of Tick size:

  1. It is the minimum price movement of a trading asset.
  2. It varies depending on the asset being traded.
  3. It determines how profitable a tick trade will be.
  4. It is significant for highly priced securities.
  5. It is typically set by the exchange where the security is traded.
  6. The tick sizes vary by exchange and by security. For example, the tick sizes for stocks listed on the National Stock Exchange of India (NSE) range from INR 0.05 to INR 1.

Tick Size Example

The tick size is an important consideration when buying or selling shares. It is the minimum amount by which the price of a security can change. For example, a stock has a tick size of Rs. 0.5; the price can go up or down in increments/decrements of Rs. 0.5. Suppose the last traded price (LTP) was Rs.1000; then the following best bid prices for the stock shall be Rs.999.95, Rs.999.90, Rs.999.85, Rs.999.80, and Rs.999.75. Here, the tick size is set at Rs.0.05. Therefore, the bid price can not be Rs.999.87.

In India, the Securities and Exchange Board of India (SEBI) has stipulated the following Tick Sizes for stocks:

- Rs. 1 for stocks with a market capitalization of more than Rs. 10,000 crore

- Rs. 0.5 for stocks with a market capitalization of Rs.4,000 to Rs. 10,000 crore

- Rs. 0.05 for stocks with a market capitalization of less than Rs. 4,000 crores

The main reason for having different Tick Sizes for different stocks is to ensure adequate liquidity in the market for all stocks. With a large Tick Size, it would be difficult to find buyers or sellers for some of the less liquid stocks, and this would lead to wider bid-ask spreads and make it difficult for investors to trade these stocks. Thus, by having different Tick Sizes, SEBI safeguards sufficient liquidity in the market for all stocks while ensuring that investors can trade at reasonable prices.

Additionally, to guarantee that market orders are executed efficiently and at the best possible prices, SEBI has mandated that all stocks listed on Indian stock exchanges must have a tick size of Rs. 2 per share. This rule was put into effect in 2017, with a phase-in period. By requiring tick sizes for all stocks, SEBI aims to improve liquidity and tighten spreads in the market.

Conclusion:

Tick trading offers several advantages for traders, including tighter spreads, faster execution, and increased liquidity. Moreover, it is advantageous because it helps ensure prices stay close to the true value while providing better opportunities for smaller investors. If you're looking to trade stocks in India, consider using tick orders to take advantage of these benefits. At Bajaj Securities, we always look for new and innovative ways to help our clients grow their investments. One such step taken was to incorporate tick trading into our investment offerings. You can download the app here.

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