Summary: The tick size is the smallest measurable amount the price of a financial instrument can move. Different instruments have a different tick size, for example, the tick size of a share is 0.01 because that equals one cent. Some futures contracts have designated tick sizes, which can be up to $10.00.
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A successful trading journey starts with understanding the basics of trading. In this article, we’ll cover tick sizes and their relation to transaction costs in trading, and explain the main changes that are introduced by the Tick Size Pilot Program.
Tick Size Definition
A tick represents the minimum increment that a financial instrument can change in price, either up or down. Tick sizes are important as they determine the potential profit or loss of a trade setup, and also play a major role in the calculation of transaction costs.
How Much is a Tick Worth?
The value of a single tick depends on the financial instrument that you’re trading. In stocks trading, the minimum price fluctuation of a stock trading above $1 is 1 cent. This means, if a stock is currently trading at $20.54, the next possible price-levels are $20.53 and $20.55.
Each tick in a stock’s price is represented by a tick size chart, which also conveniently shows the bid and ask prices for a stock. However, to technically analyze the price using data collected from historical price movements, you should focus on the price chart instead of the tick chart.
Tick Sizes in Forex
Different financial markets have different tick size regimes. In the Forex market, the minimum tick size that an exchange rate can move is called a pip, and represents the fourth decimal place of an exchange rate. In some currency pairs that include the Japanese yen, a pip can also be located on the second decimal place.
The value of the minimum price fluctuation in the Forex market depends on the traded currency pair, the current exchange rate and the position size of your trade. The tick value in all financial markets also plays an important role in ratio analysis and risk management, such as your risk-per-trade, reward-to-risk ratio etc. Tick sizes are used in various markets, but if you know what is a stock tick, you won’t have problems in understanding futures, Forex or bond tick sizes.
Tick Size and Transaction Costs
Minimum price movements are also used by online brokers to set transaction costs. When trading stocks and futures contracts, you may also pay a small commission for opening a trade, in addition to the difference between the bid and ask prices.
In the Forex market, the difference between the bid and ask prices (called the “spread”) is usually the only transaction cost you’ll need to pay. The spread is represented in pips, which are the minimum tick sizes in the Forex market. Most ECN brokers and market makers offer very competitive spreads nowadays, which can be as low as 1 pip on major currency pairs.
Tick Size Pilot Program
The Tick Size Pilot Program has been implemented in 2016 with the goal to widen the minimum quoting and tick sizes for publicly available small capitalization stocks. The Program’s objective is to study the effect of different tick sizes on the liquidity and trading of stocks with small market capitalizations, in order to improve the overall market quality. Under the Tick Size Pilot Program, the tick size of selected stocks will be widened from $0.01 to $0.05.
The Pilot program will include a subset of companies that have a market capitalization of $3 billion or less, an average daily trading volume of one million stocks or less, and a minimum price of $2 for every trading day.
A total of 1,400 securities are divided into three test groups, with a control group that will trade at the current $0.01 tick size. The first test group includes pilot securities that are quoted in $0.05 increments, but that continue to trade at $0.01 price increments. While pilot securities in the second and third group are both quoted and traded at $0.05 price increments, securities in the third group are also subject to certain requirements that prevent price matching by exchanges that have different quotations.
The Pilot program will last for 2 years, starting from October 2016. If you’re wondering how the pilot program could affect your trading, you should take a look at SEC’s website or contact certified financial advisors to prevent costly mistakes down the road.
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Other Trading Basics
Backwardation occurs when a bid price exceeds the ask price.
This usually occurs when stock is suspended or under a share repurchase scheme.
It can also mean that a futures contract will trade at a higher price when it is coming close to expiring.
The opposite of backwardation is known as contango.
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