On May 24, 2024, the National Stock Exchange of India (NSE) issued a circular (Ref. No: 66/2024) detailing a significant revision in the tick size of securities in the Capital Market Segment (CM Segment). This change, effective from June 10, 2024, introduces a price-linked tick size mechanism, impacting all securities listed in the Cash Market Segment. Let’s get into the details of this circular, understand why NSE is implementing these changes, and discuss why it’s crucial for traders, particularly algorithmic traders, to pay close attention.
What is Tick Size?
Tick size is the minimum price movement of a trading instrument. For instance, a tick size of Rs 0.05 means that the smallest price increment in which a security can be traded is Rs 0.05.
Key Highlights of the Circular
1. Introduction of Price-Linked Tick Size:
• The tick size for a security will now be determined based on its closing price on the last trading day of the previous month.
• For securities priced below Rs 250, the tick size will be Rs 0.01, while for those priced at Rs 250 or above, the tick size will remain at Rs 0.05.
2. Monthly Review Mechanism:
• NSE will review and potentially adjust the tick size of securities on a monthly basis.
• The new tick size will be applicable from the first trading day of each month, based on the closing price on the last trading day of the previous month.
3. Applicability to New Listings and Corporate Actions:
• For new IPOs, the tick size will be based on the issue price. If the reference price is below Rs 250, the tick size will be Rs 0.01.
• For securities listed on other exchanges and then listed on NSE, the tick size will be determined similarly.
• In cases of corporate actions like splits, bonuses, dividends, and rights issues, the existing tick size will continue until the next review.
4. Alignment of Price-Related Computations:
• All price-related computations such as closing price, base price, common equilibrium price, and settlement price will be aligned with the applicable tick size.
5. Implementation Details:
• Trading members must update their trading applications with the new security files provided by NSE.
• The circular will be effective from June 10, 2024, with the initial tick size based on closing prices as of May 31, 2024.
Why is NSE Implementing This Change?
The primary goal of this revision is to enhance liquidity and trading efficiency. By aligning tick sizes with security prices, NSE aims to:
1. Improve Market Depth:
• Smaller tick sizes for lower-priced securities can lead to tighter bid-ask spreads, thereby increasing liquidity and market depth.
2. Reduce Price Manipulation:
• A price-linked tick size mechanism can help mitigate the risk of price manipulation by ensuring that tick sizes are proportionate to the price of the security.
3. Facilitate Fairer Trading:
• This change ensures that both high and low-priced securities are traded with an appropriate tick size, promoting fairer trading practices across the market.
Why Should Algo Traders Pay Attention?
Algorithmic traders, who rely heavily on precise price movements and market efficiencies, need to be particularly attentive to these changes for several reasons:
1. Strategy Adjustments:
• Many algorithmic trading strategies are sensitive to tick size. Smaller tick sizes can lead to more frequent trading opportunities and potentially higher transaction volumes.
2. Impact on Liquidity Models:
• Algorithms that model market liquidity need to be updated to reflect the new tick sizes. This can impact how orders are placed and executed.
3. Execution Algorithms:
• Execution algorithms that aim to minimize market impact will need to adapt to the new tick size regime to ensure optimal order placement and execution.
4. Backtesting and Simulations:
• Historical backtesting and simulations must be recalibrated to account for the revised tick sizes. This ensures that the performance of trading strategies remains accurate and reliable.
Reduced Slippage Costs for Algo Traders
One of the significant benefits of the new tick size regime is the potential reduction in slippage costs, particularly for algo traders who frequently place market orders. Slippage occurs when there is a difference between the expected price of a trade and the actual price at which the trade is executed. Here’s how the new tick size mechanism can help reduce slippage:
1. Tighter Bid-Ask Spreads:
• Smaller tick sizes, especially for lower-priced securities, result in tighter bid-ask spreads. This means that the difference between the buying and selling prices narrows, reducing the cost of executing trades at market prices.
2. Increased Market Liquidity:
• With more frequent price increments, the market depth increases. Higher liquidity means there are more orders available at various price levels, reducing the likelihood of large price jumps when executing market orders.
3. Better Price Execution:
• For algo traders, particularly those employing high-frequency trading (HFT) strategies, better price execution is crucial. The ability to trade in smaller price increments allows for more precise order placements, leading to better execution prices and lower slippage.
4. Enhanced Order Book Dynamics:
• The introduction of price-linked tick sizes can lead to more robust order book dynamics. With a more granular pricing mechanism, the order book becomes more competitive, allowing for improved trade matching and reduced slippage.
NSE’s revision of tick sizes represents a significant shift aimed at enhancing market efficiency and liquidity. For traders, especially those employing algorithmic strategies, staying informed and adapting to these changes is crucial. By understanding the implications and adjusting their trading systems accordingly, algo traders can continue to optimize their strategies and maintain a competitive edge in the market. As always, staying updated with regulatory changes and continuously refining trading models will be key to success in the dynamic world of stock trading.
The reduction in slippage costs due to tighter bid-ask spreads and increased liquidity will particularly benefit algo traders who rely on precise price movements for optimal trade execution. This change not only enhances market efficiency but also provides a more conducive environment for sophisticated trading strategies.
