Bid–ask spread

The simplest type of bid-ask spread is the quoted spread. This spread is taken directly from quotes, that is, posted prices. Using quotes, this spread is the difference between the lowest asking price (the lowest price at which someone will sell) and the highest bid price (the highest price at which someone will buy). This spread is often expressed as a percent of the midpoint, that is, the average between the lowest ask and highest bid: ${\displaystyle {\text{Quoted Spread}}={\frac {{\hbox{ask}}-{\hbox{bid}}}{\hbox{midpoint}}}\times 100}$.

Quoted spreads often over-state the spreads finally paid by traders, due to "price improvement", that is, a dealer offering a better price than the quotes, also known as "trading inside the spread".[3] Effective spreads account for this issue by using trade prices, and are typically defined as: ${\displaystyle {\text{Effective Spread}}=2\times {\frac {|{\hbox{Trade Price}}-{\hbox{Midpoint}}|}{\hbox{Midpoint}}}\times 100}$. The effective spread is more difficult to measure than the quoted spread, since one needs to match trades with quotes and account for reporting delays (at least pre-electronic trading). Moreover, this definition embeds the assumption that trades above the midpoint are buys and trades below the midpoint are sales.[4]

Quoted and effective spreads represent costs incurred by traders. This cost includes both a cost of asymmetric information, that is, a loss to traders that are more informed, as well as a cost of immediacy, that is, a cost for having a trade being executed by an intermediary. The realized spread isolates the cost of immediacy, also known as the "real cost".[5] This spread is defined as: ${\displaystyle {\text{Realized Spread}}_{k}=2\times {\frac {|{\hbox{Midpoint}}_{k+1}-{\hbox{Traded Price}}_{k}|}{{\hbox{Midpoint}}_{k}}}\times 100}$ where the subscript k represents the kth trade. The intuition for why this spread measures the cost of immediacy is that, after each trade, the dealer adjusts quotes to reflect the information in the trade (and inventory effects).

Inner price moves are moves of the bid-ask price where the spread has been deducted.