Impact cost



Key Takeaways

  1. Impact cost is a measure of the stock or security liquidity.
  2. 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

Impact cost is a measure of the stock or security liquidity. Impact cost refers to the expense of executing a transaction of a given index or security with a specific order size. Impact cost shows the impact on a stock price when stocks are bought or sold in large quantities by an investor. Impact cost is a realistic and pragmatic measure of a 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 QuantityBuy PriceSell PriceSell Quantity
10009.809.901000
20009.7010.001500
30009.6010.10100

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%