Market impact – the effect your trading has on the wider market, post trade

LMAX Exchange

LMAX Exchange

One of the key metrics you need to consider in your choice of liquidity and transaction cost analysis, is market impact. Or put simply, the effect your trading has on the wider market post trade. Rather simplistically you are told that, if the market moves a lot in reaction to your trading, then that’s a bad thing and you pay wider spreads with a high cost of rejection and higher response times.

david-mercer-thumbnail

Video commentary by David Mercer, LMAX Exchange CEO

But, if you trade on ‘last look’ prices, lower market impact would mean you benefit from tighter spreads and lower cost of rejections and hold times. Let’s take a deeper look at this. The easy one first.

If your flow is benign and looks a bit like this:

and you trade on firm liquidity, the cost of rejection and hold time, should be close to zero. The same should also be true on ‘last look’ venues, if it isn’t, then you must add those costs to your spread and commission calculations.

What if your flow is more informed, lo and behold, even profitable? Your flow may look like this:

and the next question is, do you actually desire market impact?

If you’re a day trader, I would argue yes. Your key considerations then should be, fill rates and any cost of hold times or rejection, it is obvious in this case that firm liquidity with much higher fill rates and lower cost of hold time and zero cost of rejection is better for you. However, it is unlikely that you will see the tighter spread available and you’re probably happy to pay a higher spread in exchange for greater certainty of execution.

Conversely, if you’re a real money hedger, then you may want to adjust your style of trading, so as not to create too much market impact and benefit from tighter spreads – as this will form a high proportion of your hedging costs in the long term.

The reality is that your flow most likely sits between these two extremes, and your choice is not simple. You need to weigh up, spreads, fill rates, cost of rejection, cost of hold time and price improvement. Market impact is not a simple metric and we will have more details of this in our whitepaper out soon. For more information just email us at [email protected].

Any opinions, news, research, analyses, prices or other information ("information") contained on this Blog, constitutes marketing communication and it has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Further, the information contained within this Blog does not contain (and should not be construed as containing) investment advice or an investment recommendation, or an offer of, or solicitation for, a transaction in any financial instrument. LMAX Exchange has not verified the accuracy or basis-in-fact of any claim or statement made by any third parties as comments for every Blog entry.

LMAX Exchange will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information. No representation or warranty is given as to the accuracy or completeness of the above information. While the produced information was obtained from sources deemed to be reliable, LMAX Exchange does not provide any guarantees about the reliability of such sources. Consequently any person acting on it does so entirely at his or her own risk. It is not a place to slander, use unacceptable language or to promote LMAX Exchange or any other FX, Spread Betting and CFD provider and any such postings, excessive or unjust comments and attacks will not be allowed and will be removed from the site immediately.

LMAX Exchange will clearly identify and mark any content it publishes or that is approved by LMAX Exchange.

FX and CFDs are leveraged products that can result in losses exceeding your deposit. They are not suitable for everyone so please ensure you fully understand the risks involved. The information on this website is not directed at residents of the United States of America, Australia (we will only deal with Australian clients who are "wholesale clients" as defined under the Corporations Act 2001), Canada (although we may deal with Canadian residents who meet the "Permitted Client" criteria), Singapore or any other jurisdiction where FX trading and/or CFD trading is restricted or prohibited by local laws or regulations.