What Is Tick Size in Stock Market Trading?

Key takeaways:

• Tick size determines the smallest possible price movement of a stock

• It must be verified before placing order limits

• An intraday trader must prefer highly liquid stocks with smaller tick sizes 

• The difference between tick size and lot size is clearly explained

Introduction:

The stock market may look simple on the surface. A type of platform where the company’s shares are displayed, featuring trending charts that show prices fluctuating, with red and green colours dominating market activity. This movement is supported by a systematic framework that governs how prices change. One of the most fundamental and often overlooked concepts in this system is tick size.

For anyone involved in trading tick strategies in the equity market, intraday trading, algorithmic trading, or long-term investing, it is essential to understand tick size. It directly affects order placement, liquidity, ask & bid spreads, trading costs, and price discovery in the equity market. 

In this blog, learn the concepts of what tick size is, how tick trading works, why tick size matters, how it impacts traders and investors, and how tick size is defined in the Indian equity market.

Tick Size in Trading Tick:

It is the minimum price movement allowed for financial instruments such as equities, foreign exchange (forex), futures, options, and other traded assets across financial markets.

In simple words, tick size is the smallest possible change in the price of the security.  For example, if the tick size is Rs. 0.05, then the prices can move as Rs. 100.05, Rs. 100.10 or Rs. 99.95 but not Rs. 100.02. 

The smallest price movement is called one tick, and trading strategies based on these movements are called trading tick approaches. 

Trading tick in the Equity Market:

Trading ticks in the equity market is nothing but trading strategies that focus on the small price movements (ticks) rather than :arge directional moves. These strategies vary depending on the tick size of the instrument.

Tick Size Importance in the Equity Market:

Tick size is the backbone of trading tick strategies. It improves liquidity and market efficiency, influences the cost of execution and profitability, and impacts bid-ask spreads. Also, the smaller the tick size, the finer the price movement available for trading.

Investors must know the reason for the existence of tick size in the equity market, which is as follows:

• Prevents price manipulation and upholds fair competition among traders

• Enhances price discovery

• Maintains market stability

• Strikes a balance between liquidity and volatility 

• Limit order prices must comply with the tick size

If tick size is undefined, prices could fluctuate randomly by extremely small values, which could lead to chaos in the equity market. 

In India, tick size is regulated by SEBI (Securities and Exchange Board of India) and implemented by exchanges like NSE and BSE. It is expressed in decimal numbers with an ordered pattern. 

Impact of Tick Size in the Equity Market:

When it comes to its impact on the equity market, tick size directly affects trade execution.  The impact on price movements, bid-ask spreads, and liquidity is elaborated below:

Price Movements – 

They refer to the upward or downward shifts in a security’s value over specific periods, often affected by the demand-supply imbalances, with other factors like company earnings, news and overall market sentiment.

When the tick size is smaller, it allows finer price movements, encourages active trading and improves price efficiency. When the tick size is larger, it causes price jumps, reduces trading frequency and benefits long-term investors more than scalpers.

Bid-Ask Spreads – 

It is the primary measure of market liquidity and hidden transaction costs for traders. The bid is the demand for the security, and the ask is the supply. The spread is calculated as: Spread = Ask price – Bid price

It shows the difference between the highest price a buyer is willing to pay for the security (bid) and the lowest price a seller is willing to accept (ask). The smaller ticks lead to narrower spreads, and larger ticks lead to wider spreads. 

The narrow spread refers to the small difference between ask and bid prices, which indicates-

• High market liquidity

• High trading volume

• Lower transaction costs 

The wider spread is the opposite of the narrow spread, with an increased difference.

Liquidity –

Liquidity in the equity market is the ease of buying and selling shares, without affecting their market price. A small tick size improves liquidity, more price points encourage more orders, and the order book becomes deeper.

Tick size vs Lot size:

A term called “lot size” is the standard minimum quantity of shares that must be bought or sold in a single transaction. Many beginners confuse tick size with lot size, where both are completely different. The table showing the difference is as follows-

In the cash market, tick size matters more than the lot size, as ticks or minimum price movement is the crucial component for liquidity and transaction costs for every single trade, as well as an important factor to trade in small shares.

Conclusion:

Tick size influences price movements, liquidity, and bid-ask spreads. While smaller tick sizes enhance price precision and trading activity, larger tick sizes can lead to wider spreads and less frequent trades. Understanding tick size helps traders make better decisions, manage costs, and choose suitable strategies based on their trading style.

Frequently Asked Questions (FAQs)

1. Is tick trading suitable for beginners?

No, tick trading is not suitable for beginners as they often struggle with overtrading, delayed executions and emotion-driven decisions. 

2. Do long-term investors need to worry about tick size?

No, tick size has minimal impact on the long-term returns, and long-term investors focus on the fundamentals, business growth and valuation. Over long holding periods, broader price movements dominate tick-level fluctuations.

3. Where can traders check the tick size of a stock?

Tick size of a stock can be checked through the exchange websites, trading terminals and broker platforms. Prices that enter outside the tick size rules are automatically rejected. Regularly check the tick size, as rules may vary by segment and changes may occur via regulatory updates.

4. Can tick size affect trading costs and slippage?

Yes, tick size can affect trading costs and slippage. It directly impacts bid-ask spreads. The wider the tick size, the wider the spread and the higher the hidden costs. Large tick size increases the slippage. 

5. Why are market orders risky in large tick size stocks?

Market orders execute at the best available price. They are risky in large tick size stocks, as there are bigger price jumps and fewer price points, which causes poor execution prices and unexpected slippage. This increases the risk during volatile markets and low-volume periods.

6. Does a smaller tick size always mean better trading?

No, a smaller tick size doesn’t always mean better trading. Though it improves price precision and liquidity, it also increases competition, noise and speed dependency. Effectiveness depends on the trading style, market conditions and execution capability.  

7. Are the tick size rules the same for all stocks and segments?

No, the tick size rules are not the same for all stocks and segments. They are required to balance market liquidity, volatility and trading efficiency based on the specific characteristics of the security.