What is tick size?
Tick size represents the minimum price movement – up or down – of a financial instrument in a financial market.
Put differently, tick size is the minimum increment a financial market can display between the buy and sell prices of a trading instrument such as a security. Essentially, it determines the amount by which the price of a financial instrument can vary with each trading transaction.
The way tick size works
Tick size plays an important role in trading and investing because it determines a potential loss or profit. In addition, tick sizes play a key role in the calculation of transaction costs.
In present-day trading, tick sizes typically have a basis of decimals, also referred to as the decimal system in which a decimal point (dot) is used to represent decimal fractions. For example, 0.01 represents one cent of the US dollar (USD) or one cent of the South African Rand (ZAR).
Tick sizes may vary depending on the type of financial market, types of financial instruments, value of the trade, and volume.
For instance:
- Stocks (shares) typically trade in one-cent movements in stock exchanges in the USA. In South Africa, the Johannesburg Stock Exchange allows tick sizes of one South African cent in the trading of shares since May 2002. For example, if the shares of a company are trading at R20.35 on the JSE, the next possible price levels are R20.34 and R20.36.
- Rates have tick sizes in basis points (bps), for example, an increase in an interest rate from 5 percent to 5.5 percent represents 50 basis points.
- Futures contracts have a tick size that is specific to the instrument. For instance, an E-Mini S&P 500 futures contract has a tick size representing 25 percent (0.25) of an index point, which is calculated at US$50. Hence, one tick equals US$ 12.20.
- In the forex market, tick sizes called pips are used. See the subject below, Tick size in forex trading, for more information.
The greater the tick size for a financial instrument, the fewer ticks it has to move to generate the same price change, compared with a financial instrument with a smaller tick size.
Although there are different tick sizes used in different financial markets, once the specific tick size is set up and authorised, incremental price movements below the tick size established cannot be tracked. For instance, if the tick size of a security was R0.10, a price change of R0.05 would not be shown in the price movement.
In such a scenario, the security’s price would rise or fall by multiples of R0.10. For instance, moving upward from R20.00 to R20.10, R20.20, and so on, and contrarily, moving down from R20.00 to R19.90, R19.80, etc.
As explained above, in trading and investing, tick sizes can also be used to denote the direction that the closing price of a security has moved in relation to preceding trades. An uptick indicates an increase in the price, while a downtick refers to a decrease in the price of a security or the value of a currency.
Furthermore, tick size affects the number of ticks a financial instrument must move to generate a certain change in price. For example, the shares of a company with a tick size of one South African cent must move 1,000 ticks to affect a price change of R10.00 and 10,000 ticks to cause a price change of R100.
For an E-Mini S&P 500 futures contract to generate a price change of US$ 100, it has to move 8 ticks, because one tick represents US$ 12.50.
Tick size in forex trading
In the forex market, pips (percentage points) are used for tick size, measuring the fractional change in the value of a currency relative to the value of another currency in a currency pair.
Pips are equivalent to 1/100, 0.01 percent, or one basis point, of the value of a currency. In forex trading, currency pairs are usually priced to the ten-thousandth decimal place, four digits after the decimal point. For example, EUR/USD 1.0913.
As with a tick, a pip represents the smallest movement, referred to as a basis point, by which a currency pair can rise or decline in price. Furthermore, the value of pips indicates the spread (relationship) between the two currencies in a currency pair.
How to calculate the value of a pip:
Step #1
Divide one pip (usually 0.0001) by the current value of the currency pair.
Step #2
Multiply the figure obtained in step #1 by the lot size, which is basically the number of base units that you are trading. Lot sizes (indicating the units of a currency traded) available in forex are: nano lots (100 units), micro lots (1 000 units), mini lots (10 000 units), and standard lots (100 000 units).
Example of calculating pip value:
Let us assume the currency pair EUR/USD (where EUR is the base currency and USD is the quote currency) is trading at a market price of 1.0900, and a forex trader has a mini lot of 10,000 units. The value of a pip is calculated as follows:
(0.0001/1.0900) x 10 000 = 0.9174, meaning for every pip of movement, the trader would gain or lose 0.9174 euros.
The value of a pip will vary between currency pairs because of the variations in exchange rates.
When trading spot forex – referring to the current exchange rate at which a currency pair can be bought or sold – the pip value is usually determined by the quote currency, which is the second currency in the currency pair. In the example above, the value of one pip of movement in the quote currency (the US dollar) is calculated as follows:
10 000 x 0.0001 = 1
The importance of tick size for individual investors
Individual investors and traders should take note of the tick size of the financial instruments they are trading, or the pips involved in their forex trades.
Knowing the tick size of a security or pips related to a currency pair during a given period will enable traders and investors to determine the change in the value of the security or currency pair.
Note: This article does not constitute investment, financial or trading advice. Please obtain the advice of a professional, reputed, and regulated broker before making trading and investment decisions.
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