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Market impact

The price movement your own trading causes, split into a temporary part that decays after you stop and a permanent part that reflects information you revealed.

Slippage on a market orderA buy order clears four price levels, so the average price paid is worse than the price first quoted.Buy 1,000 shares at marketpricesell orders resting (bar length = size)20.04300 shares20.03200 shares20.01200 shares20.00300 sharesnothing resting at 20.02order sweeps up the bookaverage fill 20.02SLIPPAGE0.02 a share$20.00 in totalintended 20.00Each level fills at its own price; the average is what you really paid.
Slippage on a market order. You click at 20.00, but only 300 shares are resting there, so the rest of the order fills at 20.01, 20.03 and 20.04. The average price paid is 20.02, and that two-cent gap is slippage.

Impact is the dominant cost for large orders and the reason execution algorithms exist at all. Empirically it scales roughly with the square root of the fraction of volume you consume, so trading twice the size costs about 1.4 times the impact per share, not twice.

Temporary impact is the liquidity you exhausted, and it recovers. Permanent impact is the market updating its view because you traded, and it does not.

Example: a model estimates impact as 0.4 x volatility x sqrt(order size / daily volume). With 30% annual volatility (about 1.9% daily), an order of 5% of daily volume implies 0.4 x 1.9% x sqrt(0.05) = 0.17%, roughly 17 basis points. On $5 million that is $8,500 before spread and fees.

Related: strategy-capacity, implementation-shortfall, participation-rate, realised-spread

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