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.
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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
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Execution Simulator
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Order Book Replay Visualizer
Drop a Level-2 CSV and watch the book reconstruct tick by tick. Animated depth bars, best bid/ask, spread over time. Understand microstructure before.
FAQ
Questions people ask next
The short answers readers usually want after the first pass.
Sources & References
- Dealership Market: Market-Making with Inventory — Amihud, Mendelson (1980), Journal of Financial Economics 8(1)
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