Impact cost
Key Takeaways
- Impact cost is a measure of the stock or security liquidity.
- Impact cost occurs when an investor is executing a transaction because of the prevalent liquidity conditions.
The impact cost of a trade is the cost incurred when the security’s price changes triggered by the high demand from a bulk order.
Example
If we were to buy a million shares at Rs 50, the size of the order may be large enough for the share prices to start rising following the excessive demand, and by the time we complete our purchase, the spot price could have risen to Rs 56, with our purchases paying for the incremental rise for the units left to buy as we go acquiring.
Impact Cost meaning
The Liquidity of the stock or asset is measured by impact cost. Impact cost is the price associated with carrying out a transaction for a particular index or securities with certain order size. Impact cost depicts the effects of an investor’s large-scale purchases or sales of stocks on a stock’s price. Impact cost is a practical and reasonable way to gauge market liquidity.
Impact Cost Formula
Ideal Price = (Best Buy Price + Best Sell Price)/2
Impact Cost = (Actual Buy Price – Ideal Price) * 100/ Ideal cost
Example:
| Buy Quantity | Buy Price | Sell Price | Sell Quantity |
| 1000 | 9.80 | 9.90 | 1000 |
| 2000 | 9.70 | 10.00 | 1500 |
| 3000 | 9.60 | 10.10 | 100 |
Buy Quantity is 1000 and Buy Price is 9.80 and Sell Price 9.90 and Sell Quantity is 1000.
Now to buy 1500 shares, the ideal price would be = ((9.80+9.90))/2 = 9.85 i.e. the best bid plus best offer divided by 2 or taking average of best bid and best offer.
Actual Buy Price = [(1000*9.9) + (500*10.00)]/1500 = 9.93
Impact cost for 1500 shares [(9.93 – 9.85)/9.85] * 100 = 0.84%