Tick Size and Price Improvement: A Beginner’s Guide

When you start learning about day trading, you’ll often come across terms like tick size and price improvement. These concepts are fundamental to understanding how stock prices move and how traders can potentially get better deals when buying or selling shares. This article will break down these terms in simple language, explain why they matter, and show you how they can impact your trades.

What Is Tick Size?

Tick size is the smallest possible price movement a stock can make. Think of it as the smallest "step" up or down in the price. For example, if a stock is trading at $50.00 and the tick size is $0.01, the next possible prices are $50.01 or $49.99.

Why Does Tick Size Matter?

• Price Precision: Tick size determines the price increments at which buyers and sellers can place orders.
• Liquidity and Spreads: Smaller tick sizes generally mean tighter bid-ask spreads, which can lower trading costs.
• Market Efficiency: Appropriate tick sizes help markets operate smoothly by balancing order competition and price discovery.

Examples of Tick Sizes

• For U.S. stocks priced above $1.00, the tick size is usually $0.01.
• For stocks under $1.00, tick sizes might be $0.0001 or $0.001.
• Some futures or options contracts use different tick sizes, such as $0.25 or $0.10 increments.

How Tick Size Affects Your Trades

Imagine you want to buy 100 shares of a stock trading at $20.00 with a bid price of $19.99 and an ask price of $20.01. The bid-ask spread is $0.02, which is two ticks if the tick size is $0.01.

If the tick size were larger, say $0.05, the spread might be $0.05 or more, increasing your trading cost. Conversely, a smaller tick size allows for tighter spreads, meaning you could pay less when buying or get more when selling.

Real-World Example

• Stock price: $50.00
• Tick size: $0.01
• Bid price: $49.99
• Ask price: $50.00

If you place a limit buy order at $49.99, you might have to wait longer to get filled, but if you are willing to buy at $50.00, your order will execute immediately.

What Is Price Improvement?

Price improvement occurs when a trader’s order is executed at a better price than the current bid or ask price. This means you pay less when buying or receive more when selling than you expected.

How Does Price Improvement Work?

• When you place a market order, your broker routes it to exchanges or market makers.
• Sometimes, these intermediaries can fill your order at a better price than the quoted price.
• For example, if you want to buy at $10.00 (ask price), you might get filled at $9.99, saving you $0.01 per share.

Benefits of Price Improvement

• Lower Trading Costs: Even small savings per share add up, especially in large trades.
• Better Trade Execution: Price improvement can increase your overall profitability.
• Increased Market Efficiency: Encourages competition among market makers and exchanges.

How to Take Advantage of Tick Size and Price Improvement

1. Use Limit Orders Strategically

Placing limit orders allows you to specify the maximum price you’re willing to pay or the minimum price you want when selling. You might get price improvements if the market moves favorably.

• Example: Set a buy limit order at $20.00 when the ask is $20.01. If the market moves down, you could get filled at $20.00 or better.

2. Understand the Bid-Ask Spread

The spread is the difference between the highest bid and lowest ask price. Smaller tick sizes generally create tighter spreads.

• Tip: Trade stocks with tight spreads to reduce costs.
• Watch for stocks with unusually wide spreads — these can increase your trading costs.

3. Monitor Market Conditions

Price improvement opportunities tend to be more frequent in highly liquid stocks with high trading volumes.

• Highly liquid stocks often have spreads just one or two ticks wide.
• Less liquid stocks may have wider spreads and fewer price improvement chances.

4. Consider Order Size

Large orders may have a harder time getting price improvement because they consume more liquidity.

• Smaller, more frequent orders might benefit from better price improvements.
• Be mindful of trading fees and commissions when breaking orders into smaller pieces.

Summary: Practical Impact for Beginner Traders

• Tick size defines the smallest price move and influences bid-ask spreads.
• Smaller tick sizes generally reduce trading costs by tightening spreads.
• Price improvement means getting a better price than expected, lowering your cost or increasing your sale proceeds.
• Using limit orders and trading liquid stocks can help you benefit from price improvement.
• Always factor in tick size and spreads when planning trades to optimize your execution.

Key Takeaways

• Tick size is the minimum price increment for a stock, usually $0.01 for stocks over $1.00.
• Smaller tick sizes often lead to tighter bid-ask spreads, reducing trading costs.
• Price improvement occurs when your order fills at a better price than the quoted bid or ask.
• Using limit orders and trading liquid stocks increases your chances of price improvement.
• Understanding these concepts helps you make smarter trading decisions and improve profitability.

This article is for educational purposes only and does not constitute financial advice. Day trading involves substantial risk of loss.