Tick size affects the prices that investors can offer when trying to buy or sell shares. In effect, it determines the amount by which a share’s price can change with each transaction. Behind the scenes, there are usually many investors who have active buy and sell orders for XYZ. There may be many people willing to sell for more than $25.73, and many looking to buy for less than $25.73. If XYZ is a highly liquid stock, you’d likely see many sell orders at $25.74 and buy orders at $25.72. Tick size describes the smallest difference that can be displayed between buy and sell prices. In the above scenario, tick size is 1 cent because investors can see differences in buy and sell prices as small as a penny. If the tick size for XYZ were 5 cents, then in the above scenario, the market would only be able to display price differences in 5-cent increments. That means that it would show something like buy orders at $25.70 and sell orders at $25.75. Smaller tick sizes allow for more granular and accurate pricing for securities. If, for example, the tick size for stocks was $1, investors could only buy shares for prices such as $50, $51, and so on. They couldn’t offer prices like $50.27, even if that was a more accurate value for the security they wish to buy.
Example of Tick Size
Imagine a security that trades at $100. If the tick size is 5 cents, then the broker can only accept orders to buy or sell that security with prices in 5-cent increments from $100. That means it could accept orders at $99.95, $100.05, $100.10, $100.15, or $101, but not at $99.97 or $101.2 because those orders do not follow the tick-size requirement. Historically, stocks have had tick sizes of 1/16 or 1/32 of a dollar. Tick sizes are especially important when trading derivatives, such as futures. For example, an E-Mini S&P 500 futures contract has a tick size equal to one-quarter of an index point, which is valued at $50. So one tick is equal to $12.50, which is a significant difference in price. Tick size also influences the number of ticks a security must move to produce a certain price change. For example, a stock with a tick size of one penny must move 10,000 ticks to produce a price change of $100, while an E-Mini S&P 500 futures contract must move just eight ticks to produce the same price change.
What It Means for Individual Investors
Individual investors should pay attention to the tick size of the securities they’re buying. If you know how many ticks a security typically moves during a period, knowing the tick size will let you determine the change in its value.
