Impact Cost

Impact cost is the cost a buyer or a seller incurs while executing a transaction. This cost is dependent on the existing market liquidity. In other words, it represents the cost of executing a transaction of a given security, with specific predefined order size, at any given point of time.

 

Example:

 

Buy Quantity	Buy Price (Rs)	Sell Quantity	Sell Price (Rs)
800	135	1000	136
1500	134.5	500	137
2000	133.8	2000	137.5
1500	133	300	137.6

 

If a trader places an order to buy 200 shares, it would be matched against the best ask price i.e. at Rs 136. Similarly, if he places an order to sell 200 shares, it would be matched against the best bid price i.e at 135. But if he wants to buy 100 shares and sells them immediately, he would incur a loss of bid-ask spread existing at that time i.e of Rs 1. This spread may be regarded as the transaction cost. But for a large order size, the transaction cost would be quite different from just the bid-ask spread.

This brings us to the concept of impact cost.

 

Mathematically,

 

Impact cost = (Actual cost - ideal price)* 100 / ideal cost

 

To buy 2500 shares,

Ideal Price = (135 + 136 )/ 2 =135.5 (at this price buyer can expect to ideally get a desired quantity)

 

Actual buy price =  [(1000*136 ) + (500*137) + (1000*137.5)] / 2500 = 136.8

 

Impact cost = (136.8 - 135.5)*100/135.5 = 0.95%