Key Insights on Ticks: Mastering the Basics
- A tick is the smallest allowable increment for trading a security. With decimalization, stocks trading above $1 move in one-cent increments.
- In 2016, an SEC-backed experiment increased tick sizes for 1,200 small-cap stocks from one cent to five cents, showing that increased ticks decrease trading activity and elevate costs.
Grasping the Concept of Ticks
A tick represents the smallest standardized amount by which the price of a security can fluctuate. This increment is defined in the local currency of the market where the security trades.
Before April 2001, the minimum tick size in U.S. markets was a sixteenth of a dollar, approximately $0.0625. While decimalization brought benefits like narrower bid-ask spreads and improved price discovery, it has also made market-making a less profitable endeavor.
How Ticks Operate
Different markets have distinct tick sizes based on their unique rules and securities. For instance, the E-mini S&P 500 futures contract uses a tick size of $0.25, whereas gold futures use a tick size of $0.10. If the E-mini S&P 500 is listed at $20, it can only move to $20.25 or $19.75, not any amount in between as dictated by the set tick size.
In 2015, the SEC’s tick-size expansion pilot targeted small-cap stocks to assess liquidity impact. Although expanding ticks aimed to promote brokerage engagement and funding to smaller companies, it ultimately decreased liquidity and negatively affected stock prices of selected entities.
Results of Increased Tick Sizes
Revisiting the mid-2010s, SEC considered increasing tick sizes, with brokers arguing for potential enhanced research and promotion of small-cap stocks. However, a 2016-2018 pilot program revealed unexpected outcomes – including reduced liquidity and declined stock prices.
The initiative cost significantly, from $350 million to $900 million, highlighting regulatory evolving challenges, particularly in a digital trading age. While the initial goal was to broaden brokerage interest in smaller stocks, the larger tick sizes didn’t yield expected benefits.
Understanding Tick Movements as Indicators
Ticks also indicate direction. An uptick signals a price increase from the previous trade, while a downtick denotes a decrease. A notable SEC regulation, the uptick rule, allowed only increasing price stocks to engage in short selling to avoid pushing prices lower.
In 2010, the alternative uptick rule (Rule 201) specified a 10% intra-day decline before short selling is restricted to prices above the current best bid. This rule protected investors’ long positions and mitigated intense downward pressure.
Ticks in Various Securities
U.S. stocks typically trade in one-cent increments, termed as tick sizes. On another note, a point shows the smallest shift left of the decimal point while a tick reflects the smallest shift to the right. For example, if a stock at $50.00 moves up to $51.00, it increased by one point. A shift from $50.00 to $50.01 is an increase by one tick.
Pips are akin to ticks usually applied in forex trading, marking minimal possible changes in exchange rates.
Applying Time and Tick in Trading
The Time and Tick method calculates day trade margins by considering open positions only to decide margin calls.
Related Terms: decimalization, price discovery, audit trail, pip, market order, limit order.
References
- U.S. Securities and Exchange Commission. “SEC Roundtable on Decimalization”, Page 2.
- U.S. Securities and Exchange Commission. “Assessment of the Plan to Implement a Tick Size Pilot Program”, Page 5.
- Lehalle C. Laruelle. Market Microstructure In Practice. World Scientific Publishing, 2013. Pages 67, 86.
- U.S. Securities and Exchange Commission. “SEC Announces Order for Tick Size Pilot Plan”.
- Charles Schwab. “Gold Futures”.
- CME Group. “Tick Movements: Understanding How They Work”.
- U.S Securities and Exchange Commission. “Division of Economic and Risk Analysis and Division of Trading and Markets”.
- Barron’s. “Congress’ Failed Stock Market Experiment Cost Investors $900 Million”.
- U.S. Securities and Exchange Commission. “Regulation SHO and Rule 10a-1”, Pages 2-3.
- U.S. Securities and Exchange Commission. “SEC Approves Short Selling Restrictions”.
