In the financial markets, rates change in the blink of an eye. Thanks to electronic trading, every tiny price fluctuation, whether a slight rise or a minor dip, is now instantly visible to traders. These minute movements are represented by “tick size,” which is the smallest price movement of a trading instrument. Understanding this tick size is crucial. It helps optimize trading strategies and improve trading outcomes. 

 

In this article, we will explore the significance of tick size in financial markets. We will start by defining tick size and its impact on various markets, including stocks and futures. Then, we will explain how tick size influences different trading strategies, such as scalping, day trading, and swing trading, by offering practical examples and scenarios.

 

For scalpers, we will show how low tick sizes in markets like the E-mini S&P 500 futures enable frequent, small-profit trades. Day traders will learn how to manage high tick size environments, such as low-liquidity small-cap stocks, to manage spreads and execution. Also, swing traders will understand how moderate tick sizes can help them plan trades based on larger price movements.

 

Moreover, we will discuss how to adjust trading strategies based on tick size to optimize entry, and exit points, and ensure better price execution. Let’s dive in.

What is Tick Size? 

Tick size refers to the minimum price movement. In financial markets, the tick size is the smallest increment by which the price of a security changes. This is a standardized value that varies between different types of assets and trading venues. Let us see how important tick size is based on its impact on the market:

 

Let us understand the concept of tick size through a hypothetical example.

Examples of Tick Size

In the context of stocks

• Say a stock is listed on the New York Stock Exchange (NYSE). If the tick size of this stock is $0.01, the smallest price movement it can make is $0.01. 
• This means, if the stock is currently trading at $50.00, the next possible price it could move to is either $50.01 or $49.99, and not any value in between.

 

In the context of futures contracts

• Consider the E-mini S&P 500 futures contract.
• It has a tick size of 0.25 index points.
• If the current price of the futures contract is 3000.00, the next possible price could be 3000.25 or 2999.75.

The Role of Tick Size in Different Markets 

It is essential to note that tick size in stock markets affects:

• Bid-ask spreads,
• Liquidity, and
• Overall market behavior.

 

Let us understand in detail.

Bid-Ask Spreads	Liquidity
The tick size directly influences the minimum increment by which the bid and ask prices can change.  Smaller tick sizes result in narrower bid-ask spreads. They make it cheaper for traders to enter and exit positions.  However, larger tick sizes widen the spread and increase the transaction costs.	A smaller tick size enhances liquidity by allowing for  Finer price adjustments  and Tighter spreads.  This results in higher trading volumes as participants find it easier to match buy and sell orders.  However, if the tick size is too small, it encourages excessive price changes. Also, it reduces the stability of order books.

 

For example,

The standard tick size for most stocks listed on the New York Stock Exchange (NYSE) is $0.01. This means that the price of a stock moves in increments of $0.01.

 

This $0.01 tick size allows for a high degree of price precision. It encourages more active trading and increases market depth. Also, it lets market participants adjust their orders by the smallest possible increment. This adjustment leads to:

• More efficient price discovery 

and

• Tighter spreads.

Moreover, this fine granularity helps traders optimize their strategies and reduces slippage (the difference between the expected price of a trade and the actual executed price).

How Does Tick Size Impact Futures Markets?

In futures markets, tick size affects:

• Trading volume,
• The precision of price movements, and
• The overall market environment.

 

Also, it significantly impacts contract specifications and trading volume. Let us see how:

Contract Specifications	Trading Volume
Each futures contract has a defined tick size.  These tick sizes dictate the smallest price movement for that contract. This specification is critical for traders to understand potential profits or losses per tick movement.	The tick size influences the attractiveness of a contract. Smaller tick sizes lead to higher trading volumes.  That is so because they enable finer price adjustments and attract traders who seek to exploit small price movements.  On the other hand, larger tick sizes discourage frequent trading. However, they can attract those looking for more significant price moves.

 

Let us understand this concept better by taking an example from the E-mini S&P 500 futures contract:

• Tick Size
  • The E-mini S&P 500 futures contract has a tick size of 0.25 index points.
  • Given that each tick is worth $12.50 (since one index point equals $50), the minimum price fluctuation a trader can benefit or lose from is $12.50.
• Implications for Traders
  • The 0.25 index points tick size strikes a balance between:
    • Providing enough granularity for active trading 

and

• Maintaining meaningful price changes.

• This tick size enables traders to engage in both:
  • Short-term strategies (exploiting small price movements) 

and

• Long-term strategies (focusing on broader market trends).

• The relatively small tick value encourages higher trading volumes and liquidity.
• This makes the E-mini S&P 500 futures one of the most actively traded futures contracts globally. 

The Impact of Tick Size on Trading Strategies 

Often, the financial markets witness participation from several market participants. Most trade with varied interests and employ different trading strategies, such as:

• Scalping,
• Day Trading,
• Swing Trading, and more.

 

It is pertinent to note that tick size impacts most of these trading strategies and influences trading decisions. Let us understand its impact individually for each trading strategy:

 

1. A) Scalping Strategy

For the unaware, scalping strategies rely on making profits from small price movements, usually over very short time frames. When it comes to the impact of tick size, it plays a crucial role in determining the feasibility and profitability of scalping. Let us see how:

 

Low Tick Size Markets	High Frequency of Trades
In markets with low tick sizes, such as the E-mini S&P 500 futures, scalping can be particularly effective. The small tick size of 0.25 index points enables traders to: Capitalize on minor price movements  and Benefit from tight spreads and frequent trades.	Scalpers in low-tick-size markets execute many trades to accumulate small profits that add up over time.  The tight spreads help traders in: Minimizing transaction costs and Enhancing the profitability of each trade.

 

Scalping with tight spreads was a common practice among floor traders in the past. They used to leverage the small price increments to generate consistent profits. Let us understand better through an example involving E-mini S&P 500 Futures:

• Tick Size: 0.25 index points ($12.50 per tick)
• Strategy: 
  • Say a scalper uses an advanced market analysis platform, like Bookmap, to:
    • Identify micro-trends 

and

• Quickly enter and exit positions within seconds or minutes.

• Execution:
  • The trader places buy and sell orders close to the current market price.
  • By doing so, they aim to capture a few ticks of movement in each trade.
  • Notably, tight spreads and high liquidity in the E-mini S&P 500 futures make it easier to execute trades rapidly without significant slippage.

1. B) Day Trading Strategies

Day trading involves making multiple trades within a single trading day to profit from intraday price movements. Tick size affects the ability to enter and exit positions efficiently. In markets with higher tick sizes, such as low-liquidity small-cap stocks, day trading becomes more challenging due to:

• Wider spreads 

and

• Less frequent price movements.

Furthermore, the larger tick size leads to:

• Higher transaction costs 

and

• Increased risk of slippage.

They require day traders to be more selective with their entry and exit points.

Let us understand better through an example related to Low-Liquidity Small-Cap Stock with a tick size of $0.05

 

i) Scenario	ii) Strategy	iii) Approach
A day trader monitors a small-cap stock. It has low liquidity and a tick size of $0.05. Due to the higher tick size, the bid-ask spread is wider. It ranges from $0.10 to $0.20 or more.	The trader needs to identify: Clear intraday trends  and Set precise entry and exit points. This will help them mitigate the impact of the wider spread. To control the execution price and avoid excessive slippage, the trader uses limited orders.	Given the wider tick size, the trader focused on fewer, larger trades instead of numerous small trades. They aim to capture more substantial intraday price movements to compensate for the higher transaction costs.

 

1. C) Swing Trading Strategies

Swing trading involves holding positions for several days in order to capture larger price movements. Tick size influences the planning of entry and exit points based on expected price swings. It must be noted that in markets with moderate tick sizes, such as mid-cap stocks, swing traders can balance the need for precise entry and exit points with the ability to capture significant price movements over several days.

Besides, moderate tick size allows for relatively tight spreads. This helps traders to take advantage of broader price trends. Let us understand this better through an example involving a mid-cap stock with a tick size of $0.02:

 

Scenario	Strategy	Execution
A swing trader identifies a mid-cap stock with a moderate tick size of $0.02.  They analyze the stock’s price chart to identify potential support and resistance levels. They plan to hold the position for a few days to a few weeks.	The trader sets entry and exit points based on: Technical indicators  and Expected price swings. For example, if the stock is trading at $50.00, they might place a buy order at $50.10, anticipating a rise to $52.00.	The moderate tick size permits comparatively precise entry and exit points. They enable the trader to capture a significant portion of the anticipated price movement while managing transaction costs effectively.

 

How to Adjust Your Strategy Based on Tick Size?

Understanding tick size is crucial for:

• Optimizing entry and exit points,
• Avoiding slippage, and
• Improving execution.

 

Let us check out some proven strategies for optimizing entry and exit points:

• High Tick Size Markets
  • In high tick-size markets, traders need to be strategic with their order placements.
  • This helps them minimize the impact of large bid-ask spreads.
• Limit Orders
  • Traders use limit orders instead of market orders to control the execution price.
  • This helps them avoid excessive slippage that can occur with market orders, especially in high-tick-size markets.
• Order Timing
  • Traders adjust the timing of orders to take advantage of market conditions with tighter spreads.
  • For example, placing orders during periods of high liquidity can reduce the bid-ask spread impact.

For example,

• Say a low-liquidity small-cap stock has a tick size of $0.05.
• A trader identifies that the current bid-ask spread is $0.10, with 
  • A bid at $10.00 

and

• An ask at $10.10.

• To minimize the impact of the large spread, the trader places a limit order at $10.05.
• They aim to get a better price execution than a market order, which would execute at $10.10.

How to Manage Risk and Reward?

It is crucial to acknowledge that tick size affects the risk-reward ratios. To create an optimal balance between risk and reward ratios, traders must make adjustments in:

• Stop-loss 

and

• Take-profit levels.

 

Let us learn how you can do it:

Larger Tick Sizes	Stop-Loss Levels	Take-Profit Levels
In the case of larger tick sizes, set wider stop-loss and take-profit levels to account for the greater price movement increments.	Set wider stop-loss levels to avoid being stopped out by normal price fluctuations within a large tick-size market.	Take-profit levels should be set wider to capture meaningful price movements that justify the risk taken.

 

Now, let us read a hypothetical scenario involving crude oil futures with a tick size of $0.01 (worth $10 per tick).

• Strategy
  • A trader enters a position at $60.00.
  • The historical data shows the common intraday price swings of $0.50.
• Adjustment
  • To manage risk, the trader sets a:
    • Stop-loss at $59.50 (50 ticks or $500) 

and 

• Take-profit at $61.00 (100 ticks or $1000).

• This way the trader ensures that:
  • Stop-loss accounts for usual price movements 

and

• Take-profit justifies the risk.

How to Adjust Strategy in Response to Tick Size Change?

When a futures contract undergoes a change in tick size, traders need to adjust their strategies accordingly. Let us understand this concept using a case study:

Scenario

• A commodity futures contract for gold changes its tick size from $0.10 (worth $10) to $0.05 (worth $5).

Position Sizing

• A trader adjusts position sizes to account for the smaller tick size. 
• Previously, 1 tick represented $10, but now 2 ticks are required to achieve the same monetary value.

Risk Management

• Stop-loss and take-profit levels are recalibrated. 
• For example,
  • Say the original stop-loss was 10 ticks ($100).
  • Now, it needs to be 20 ticks to maintain the same monetary risk.

Outcome

• The trader sets a new stop-loss at 20 ticks and take-profit at 40 ticks.
• This way, they maintain the same risk-reward ratio but adjust to the new tick size.
• This also ensures that the strategy remains effective despite the change in tick size.

Tick Size in Cryptocurrency Trading

In cryptocurrency markets, the tick size is often flexible. You can even select it by using advanced market analysis tools like Bookmap. This selection provides significant advantages for crypto traders. See the graphic below:

Let us see through the below-mentioned example how selecting tick sizes using Bookmap helps:

• Market: Say Bitcoin is trading on a major exchange.
• Strategy
  • A trader uses Bookmap to select a tick size of $0.50 for Bitcoin.
  • This provides them with 
    • Detailed market depth 

and

• Precise order placement.

• Benefit
  • The trader executes high-frequency trades with minimal slippage.
  • They take advantage of tight spreads and frequent price movements in a highly liquid market.

Conclusion 

Tick size determines the smallest price movement of a trading instrument, and influences bid-ask spreads, liquidity, and trading costs. It has a significant impact on trading strategies and market behavior. For scalping strategies, small tick sizes in markets like the E-mini S&P 500 futures allow traders to capitalize on tight spreads and frequent trades. 

In contrast, day traders in high tick size markets, such as low-liquidity small-cap stocks, must deal with wider spreads, and adjust their entry, and exit points accordingly. Moreover, swing traders benefit from moderate tick sizes. That is because it helps them to plan trades based on anticipated price swings.

It is worth mentioning that tick size also plays a crucial role in risk management. Larger tick sizes necessitate wider stop-loss and take-profit levels to account for significant price movements. Additionally, in the flexible cryptocurrency markets, tools like Bookmap allow traders to select tick sizes that best suit their trading styles. This kind of flexibility enhances precision and adaptability. For more insights on ticks and trading, check out the detailed guide on Bookmap’s blog here.