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Market Impact
Working definition
The adverse price movement caused by an order's own execution — the difference between the prices that existed before the order began and the prices it had to reach in order to complete.
An order does not trade against a market that ignores it. Consuming resting liquidity moves the touch, and revealing that a buyer is present invites others to reprice. Market impact is the cost of both effects — the part of execution cost that would not have existed had the order never been sent.
It separates into two components with different half-lives. Temporary impact is the concession paid for demanding immediacy: depth is consumed, price moves, the book refills afterwards. Permanent impact is the part that does not revert — the market’s revision of fair value in response to what the order revealed. The distinction is not academic. Temporary impact can be reduced by trading more slowly; permanent impact cannot, and an execution schedule is essentially a trade between the two.
Across markets, instruments and decades, impact has been documented to grow roughly with the square root of quantity relative to typical volume rather than in proportion to it — sublinear, which is why size hurts less than proportionally and considerably more than not at all. The shape is a robust empirical regularity; the constants are venue- and period-specific and do not transfer.
Almost every retail backtest assumes impact is zero, and for small orders in deep instruments that is nearly true. It stops being true where a strategy scales, where it trades thin instruments, or where it fires into a liquidity void. The conditions under which impact is largest are exactly the conditions a simulation is least able to reproduce, because the price path that would have existed without the order is unobservable by construction.
Why it matters
Capacity is impact’s other name. A strategy’s edge and its impact function together decide how much capital it can carry before the edge is spent paying for its own execution, so a backtest with zero impact is a claim of unlimited capacity — a claim nobody would make in words. Measuring impact honestly means implementation shortfall accounting against a decision price, not comparing fills to a mid they helped move.
Commonly confused with
Neighbouring concepts that get used interchangeably, and the distinction that actually separates them.
- Slippage
Slippage is the whole gap between expected and realised price; impact is the part your own order caused. An order can slip because the market moved on its own, which is not impact, and it can slip because it consumed the book, which is. Attributing all slippage to impact flatters the venue; attributing none to it flatters the strategy.
- Temporary impact
Temporary impact is the concession paid for demanding immediacy — depth is consumed, price moves, the book refills. Permanent impact is the market's revision of fair value in response to what your order revealed, and it does not revert. Trading more slowly reduces the first and not the second, which is what an execution schedule is really trading off.
- Spread
The spread is the cost of crossing at the touch, present whether or not your order is large enough to matter. Impact is what happens beyond the touch, when the order is large enough that the touch is not where it finishes.
- Liquidity void
A void is depth genuinely absent before your order arrives; impact is depth your order removed. They compound viciously — the conditions under which impact is largest are usually the conditions under which the book was already thin.
How to measure it in your own data
A definition you cannot test is a definition you have to take on trust. This is the shortest honest route from the concept to a number you computed yourself.
- Records you need
A decision price with its timestamp, the full fill sequence with sizes and prices, and a reference for the instrument's typical volume over the same period. The decision price is the piece most often missing, and without it impact cannot be separated from ordinary market movement.
- What you compute
Implementation shortfall accounting against the decision price — never a comparison of fills against a mid your own order helped move, which measures your influence on the benchmark rather than your cost. Then separate the reverting portion from the portion that persists after the book refills.
- What the answer tells you
Across markets, instruments and decades, impact has been documented to grow roughly with the square root of quantity relative to typical volume rather than in proportion to it. The shape is a robust empirical regularity; the constants are venue- and period-specific and do not transfer, so a coefficient borrowed from a paper is a placeholder rather than a measurement. Note also what cannot be measured: the price path that would have existed without your order is unobservable by construction.
If this has already cost you
How much of a move your own order caused can be separated from the move the market was making anyway.
- Execution-Cost Assay“What is my execution actually costing me?”Will not establish: Whether your broker is acting against you. Cost is measurable from your side; intent is not, and a report that claimed otherwise would be selling you a story.
Intake is not open yet, so none of these can be commissioned today. They are listed here so you know the measurement exists and what it would and would not settle — the launch list hears first.
Work it out yourself
Free calculators that take this concept as an input. Each shows its working, so the number it gives you can be checked rather than taken on trust.
Questions and answers
Does market impact matter for a small retail account?
Usually not, and pretending otherwise would be dishonest — for small orders in deep instruments, assuming zero impact is very nearly right. It stops being right in three specific places: where a strategy scales, where it trades thin instruments, and where it fires into a liquidity void. Those are also exactly the conditions a simulation reproduces worst.
Why does impact grow with the square root of size rather than in proportion?
The sublinear shape is one of the more robust empirical regularities in market microstructure, observed across markets and decades. Practically it means doubling your size costs less than double in impact — size hurts less than proportionally, and considerably more than not at all.
What does market impact have to do with strategy capacity?
Capacity is impact's other name. A strategy's edge and its impact function together decide how much capital it can carry before the edge is entirely spent paying for its own execution. A backtest that assumes zero impact is therefore making a claim of unlimited capacity — which nobody would make in words.
Can I measure impact from my own trading records?
Partially, and the limitation is structural rather than a matter of effort. You can measure the realised cost against a recorded decision price and separate what reverted from what persisted. What you cannot observe is the counterfactual — the price path that would have existed had you not traded — so impact is always an estimate against a benchmark, never a directly observed quantity.
Related terms
Derived from the links this entry makes and the entries that link back to it.