Definition
Market Impact
Market impact is the adverse price movement caused by the act of trading itself, where a large buy pushes the price up and a large sell pushes it down as the order consumes available liquidity.
Market impact has a temporary component, the price snap-back after a large order is filled, and a permanent component, the lasting shift caused by the information the trade reveals. Indian execution algos model expected impact to decide how to slice orders, since trading too fast in an illiquid mid-cap can move the price several percent.
Impact cost is closely related to the impact cost measure exchanges publish for index inclusion. Minimising impact is the central purpose of execution algorithms such as VWAP, POV and implementation shortfall, which trade off impact against the timing risk of working an order slowly.
Related terms
- Execution AlgorithmAn execution algorithm is a program that works a large parent order into many smaller child orders over time to minimise market impact and achieve a target benchmark such as VWAP or the arrival price.
- Implementation ShortfallImplementation shortfall is the difference between the price of a stock when the decision to trade was made (the arrival or decision price) and the actual average price achieved, including all explicit and implicit costs.
- Impact CostImpact cost is the percentage cost of executing a specified order size relative to the ideal mid-price, and is the liquidity measure the NSE uses to assess stocks for index inclusion.
- SlippageSlippage is the difference between the expected price of a trade and the price at which it is actually executed, arising from market movement, spread and limited liquidity between order placement and fill.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.