Tick Size

Tick size defines the minimum price variation (MPV) between valid bid and offer levels. A stock with a $0.01 tick can only be quoted at prices like $10.00, $10.01, or $10.02, never $10.005. This creates a discrete lattice of permissible prices, preventing infinite fragmentation of the order book and ensuring a minimum economic incentive for liquidity providers. The grid is the foundational constraint for all order matching logic.

A wider tick size protects market makers by guaranteeing a larger minimum captured spread. This compensates them for the risk of adverse selection against informed traders.

• Wider Tick: Increases displayed depth and reduces flickering quotes, but widens the quoted spread for investors.
• Tighter Tick: Reduces explicit trading costs but can decrease depth at the top of the book, as liquidity providers earn less per round-trip trade. The optimal tick size maximizes the realized spread for liquidity providers without imposing excessive costs on end investors.

In a price-time priority market, when multiple orders rest at the same price level, the earliest order gains execution priority. A binding tick size forces traders to meaningfully improve the price to gain queue priority.

• Tick Constraint: Prevents queue-jumping by a trivial economic amount (e.g., $0.0001).
• Price Improvement: A trader must pay the full tick increment to leapfrog existing orders, rewarding the original liquidity provider for their time priority. This protects resting limit orders from being unfairly bypassed by microscopic price improvements.

The midpoint between the National Best Bid and Offer (NBBO) is often used for pegged orders and dark pool execution. When the spread is an odd number of ticks, the midpoint falls off the permissible price grid.

• Example: Bid $10.00, Ask $10.01. The midpoint is $10.005, an invalid price on a penny grid.
• Resolution: Exchanges and dark pools must define rounding rules (e.g., round down for buys) to execute midpoint pegged orders, creating a subtle execution bias relative to the true theoretical fair value.

Exchanges and regulators conduct Tick Size Pilot Programs to empirically measure the impact of varying tick sizes on market quality.

• Control Groups: Securities trading at the standard tick.
• Test Groups: Securities assigned a wider tick (e.g., $0.05) to observe changes in liquidity provider profitability.
• Trade-at Rule: Often paired with a wider tick to prevent dark pools from executing at the protected quote, forcing lit market interaction. These pilots directly inform the calibration of the maker-taker fee model and overall market structure.

Under Regulation NMS Rule 612, market participants cannot accept, rank, or display orders, quotes, or indications of interest in a pricing increment smaller than $0.01 for NMS stocks priced above $1.00 per share.

• Prohibition: Prevents stepping ahead of a protected bid or offer by a fraction of a cent.
• Exception: Orders priced below $1.00 can quote in increments as fine as $0.0001. This rule is the legal enforcement of the discrete price grid, preventing latency arbitrage strategies from exploiting sub-penny queue jumps.