Effective Spread, Realised Spread And Price Impact

Three different numbers all get casually called "the spread," and they answer three different questions. The quoted spread is just the ask minus the bid sitting in the book right now — it tells you nothing about any actual trade. The effective spread asks what a specific trade actually paid relative to the mid at the time. The realised spread asks what the liquidity provider actually kept, after the price has had time to move in response to that trade. Confusing these three is one of the most common mistakes in reading transaction cost reports.

The three definitions

For a trade at price $p$, mid $m_0$ at the time of the trade, and mid $m_\tau$ some short horizon $\tau$ later (side $= +1$ for a buy, $-1$ for a sell):

$\text{effective spread} = 2 \times \text{side} \times (p - m_0)$

$\text{realised spread} = 2 \times \text{side} \times (p - m_\tau)$

In words: effective spread doubles the distance between the trade price and the contemporaneous mid, so a trade right at the quoted half-spread reproduces the full quoted spread. Realised spread does the same thing but against the mid after the price has moved — it's what the liquidity provider is left holding once the market has digested the trade.

$\text{price impact} = \text{effective spread} - \text{realised spread}$

The gap between the two is exactly the price impact of the trade: how much the mid moved, in the trade's direction, in the time between the trade and the later mid.

Worked example

A stock quotes 99.98 bid / 100.02 ask, mid $m_0 = 100.00$, quoted spread $0.04. A buy order takes the offer at 100.02.

• Effective spread: $2 \times (+1) \times (100.02 - 100.00) = 0.04$, or $0.04 — exactly the full quoted spread, since the trade crossed the whole way to the ask.

Five minutes later, the mid has drifted up to 100.05 (the buy, or the information behind it, pushed the price further in the same direction).

• Realised spread: $2 \times (+1) \times (100.02 - 100.05) = -0.06$, or −$0.06

The realised spread is negative. The liquidity provider who sold at 100.02 is now sitting on a mark-to-market loss of $0.03/share versus the new mid, doubled in the formula to −$0.06. Price impact: $0.04 − (−$0.06) = $0.10. The full 4-cent effective spread the buyer paid, plus another 6 cents of adverse drift, is now attributed as impact — nearly all of what looked like "spread revenue" for the seller turned out to be the cost of trading with someone who moved the price.

Why this decomposition exists

A maker or exchange reporting only the quoted spread is describing an advertised price, not a cost anyone actually paid. Reporting the effective spread is closer to reality but still credits the maker with the full amount, ignoring that a big chunk of it may evaporate as the price keeps moving. Only the realised spread net of impact tells you what liquidity provision genuinely earned — which is exactly the same idea as a markout, just packaged with the trade-level algebra made explicit rather than expressed as a drift number.

Where it's used

• TCA reports decompose broker or venue execution quality into effective spread paid (cost to the client) and, separately, price impact caused (cost the client's own trading pushed onto the market) — see Choosing an Execution Benchmark.
• Market quality studies use realised spread aggregated across a venue's flow as a proxy for how profitable liquidity provision is there, which feeds into decisions about maker rebate levels.
• Market maker self-assessment uses realised spread net of impact as a cleaner cousin of the markout-based P&L attribution in Markouts: Measuring Post-Trade Drift.

In interviews

If asked to define "the spread" in a trading-cost context, the sharp answer distinguishes all three: quoted (what's posted), effective (what a trade paid), realised (what the liquidity side kept after impact). The follow-up worth pre-empting is "can realised spread be negative?" — yes, and it's common: it just means the trade's own informational content pushed the price further than the spread itself, which is precisely what Market Impact describes.