How Tick Size Shapes Spreads, Order Book Depth, and Trading Costs

Summary

The note explains how an exchange’s minimum price increment affects trading costs and the structure of the limit order book. A tick size can set a lower bound on the bid–ask spread; when the spread is at that bound, a larger increment can benefit liquidity providers while increasing costs for customers. A smaller increment may narrow spreads, but also changes where orders can queue.

With smaller ticks, orders can spread across more price levels, leaving less depth at each level and contributing to more frequent small price changes. Larger ticks concentrate orders at fewer levels, where queues may be deeper and slower to advance, while prices can remain unchanged longer. These trade-offs influence the cost of immediacy and whether traders favor limit or market orders. The note offers qualitative mechanisms rather than a model, data, or a complete account of exchange rules; it does not specify how venues balance these factors when setting or changing tick sizes.

Key ideas

• Tick size can impose a floor on the bid–ask spread and affect transaction costs.
• A large tick may widen spreads and favor liquidity providers at customers’ expense.
• A small tick can distribute limit orders across more price levels, reducing depth at each level.
• A large tick can concentrate orders into deeper queues that take longer to execute.
• Tick size influences the trade-off between using limit orders and demanding immediate execution.

Tags

# How do exchanges decide the tick sizes?


# How do exchanges decide the tick sizes?












How do exchanges decide the tick sizes? I wonder which factors are taken into account to make the decision.

I know that from time to time tick sizes are changed, e.g. https://web.archive.org/web/20170623220320/http://www.cmegroup.com/tools-information/lookups/advisories/ser/files/SER-7425.pdf?mkt_tok=3RkMMJWW:

## Answer by Alex C (score 1)

https://quant.stackexchange.com/a/34840

(1) The tick size puts a lower bound on the bid-ask spread (and often is equal to the bid-ask spread)

Tick size too big: the bid-ask spread (which the market maker earns but the customers pay) is too big. Favors the market-makers at the expense of the customers.

Tick size too small: vice versa.

Therefore the tick size influences the transaction cost.

(2) The tick size is inversely proportional to the number of levels where limit orders can accumulate.

Tick size to small: many price levels to choose from, relatively few limit orders at each price level (short queues). Relatively little depth at each level and therefore frequent small changes in price (microvolatility).

Tick size too large: few price levels, each with many limit orders queued. Prices stay constant for a long time without changing, but limt orders take a long time to move to the front of the queue and get executed.

Influences the "cost of immediacy" i.e. whether limit orders or maket orders are favored.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.