What trading really costs
Costs come in two kinds. Explicit costs are charged on a statement: commissions, exchange and clearing fees, regulatory fees and taxes. Implicit costs never appear as a line item but are usually larger: the bid-ask spread, the price move your own order causes (market impact), and the drift in price while you wait or work the order (slippage).
Crossing the spread costs half of it: buying at the ask instead of the mid price loses ask − mid, and a round trip (buy at the ask, sell at the bid) costs the whole spread. In basis points, the half-spread is spread / (2 × mid) × 10,000. Market impact grows with the size of your order compared with the stock's average daily volume, roughly with its square root: ten times the size does not cost ten times as much per share, but it costs more per share.
The standard measure of total cost for one decision is the implementation shortfall: how much worse the result is than if you had traded everything instantly at the decision price.
- Explicit costs: commissions, exchange and clearing fees, regulatory fees, taxes.
- Spread: the gap between best ask and best bid; crossing it costs half.
- Market impact: the price move caused by your own order.
- Slippage: the gap between the decision price and what you actually get.
Lab · what's graded
- Kinds of cost20 pts
- An explicit cost10 pts
- Reducing market impact15 pts
- Half-spread in basis points15 pts
- Implementation shortfall20 pts
- Costs in backtests20 pts