Explainer, in Market Microstructure
Bid-Ask Spread
Quoted spread = ask − bid. Effective spread = 2 × |trade_price − midpoint| at the moment of the trade — captures price-improvement and sub-penny execution. Realized spread = 2 × |trade_price − midpoint_T_after| measures the spread net of post-trade midpoint drift, which estimates the market-maker's actual revenue. The three differ by a lot, especially in fast markets.
1 question. Published May 10, 2026. By AI Fin Hub Research.
Definition
Bid-ask spread
Quoted spread = ask − bid. Effective spread = 2 × |trade_price − midpoint| at the moment of the trade — captures price-improvement and sub-penny execution. Realized spread = 2 × |trade_price − midpoint_T_after| measures the spread net of post-trade midpoint drift, which estimates the market-maker's actual revenue. The three differ by a lot, especially in fast markets.
Why it matters
Quoted spread is what your screen shows; effective spread is what you actually pay; realized spread is what the liquidity provider actually earns. Backtests that use the quoted spread overstate profitability for liquid, fast venues (where price improvement is common) and understate it for illiquid ones (where the displayed touch is rarely actually executable in size).
How it works
Sample the order book at trade time. Compute quoted, effective, and realized spread for each trade. Aggregate by venue, time-of-day, and trade size. Use realized spread as the cost input for any strategy whose holding period is long relative to the spread-decay window — for shorter holding periods, effective spread is the relevant cost.
Example
AAPL 100-share buy at 9:35am
Bid
$192.10
Ask
$192.12
Quoted spread
$0.02
Trade price
$192.115
Midpoint
$192.11
Effective spread
$0.01
Quoted touch is 2 cents; effective spread paid is 1 cent due to mid-quote price improvement. Backtests that subtract 2 cents per round-trip overstate cost by 50% on this venue.
Key takeaways
Quoted spread is a worst-case cost; effective spread is closer to the actual cost.
Realized spread tells you what the liquidity provider keeps after adverse selection.
Spread is highly time-of-day dependent — open and close have wider spreads than mid-session.
Related terms
Run the numbers next
- Playgrounds Execution Simulator
Estimate execution cost in closed form — square-root permanent impact, linear temporary impact, half-spread, and a latency-drift band. See the slippage a naive backtest hides.
- Playgrounds Order Book Replay Visualizer
Drop a Level-2 snapshot CSV and replay the book snapshot by snapshot. Animated depth bars, best bid/ask, spread and imbalance. Understand microstructure before.
Questions people ask next
Why does the realized spread differ from the effective spread?
Because midpoint moves after the trade. If the midpoint moves toward the trade direction, the market-maker is on the wrong side of an informed trade — adverse selection — and earns less than the effective spread. Realized spread captures this.
Sources
- Dealership Market: Market-Making with Inventory , Amihud, Mendelson (1980), Journal of Financial Economics 8(1)
Keep the topic connected
- Learn Slippage
Slippage as the gap between expected and executed price: the components (spread, market impact, latency), and how to model each in a backtest.
- Learn Maker-Taker
Maker-taker fee model: makers get a rebate, takers pay. Why the model exists, what it incentivizes, and how to size up real net cost.