Bid-Ask Spread Costs for Takers and Gains for Market Makers
Summary
The document explains why spread cost depends on how an order interacts with the book. A market taker who buys at the ask or sells at the bid pays for immediate execution relative to a reference midpoint; a round trip across the quotes incurs the full spread, or two half-spreads. The half-spread is a per-side execution cost when measured against the midpoint, while the full spread captures the cost of entering and exiting by taking liquidity.
A market maker instead posts at the bid and ask and may earn the spread if both orders fill. That outcome is uncertain because passive orders may wait or not execute. The response cautions that a weighted midpoint is only a proxy for a future reference price, since trades occur at executable quotes. The example illustrates the intuition, but the discussion assumes a liquid market with a stable one-tick spread and does not quantify adverse selection, fees, or price movement.
Key ideas
- A taker pays the spread to trade immediately by crossing the book.
- Measured per side against the midpoint, the execution cost is commonly expressed as half the spread.
- A taker round trip across the bid and ask incurs the full spread before fees and price changes.
- A market maker can earn the spread when both passive orders fill, but execution is uncertain.
- A weighted midpoint is a reference estimate rather than an executable trade price.
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# Why is the half spread considered the transaction cost? # Why is the half spread considered the transaction cost? I know there are other questions that address this, but I'm a little confused on the intuition. For ex, say bid is 100, the weighted mid is 100.4, and the ask is 101. I want to sell now, so I aggress the mkt and hit the bid at 100. Which edge is my cost? By aggressing I am giving up the 0.6 edge I could have made if I submitted a sell order at the best ask. But it seems I am literally paying the 0.4 bid edge. And then if I wanted to unwind my position I'd buy at the ask and pay the 0.6 edge (the full spread). ## Answer by autoencoder (score 2) https://quant.stackexchange.com/a/80017 Whether spread should be considered as a cost or an edge/profit depends on your strategy. Let's assume that the market is very liquid and the spread is always one tick wide. A market taking strategy will buy at current best ask, and sell at future best bid, and that's one full spread (two half spreads) to pay. This ensures that orders are filled immediately with high probability. A market making strategy will buy at current best bid, and sell at current/future best ask, and if both orders are hit, the strategy earns one full spread. Now it's quite uncertain whether your orders can be filled quickly. Thus, you can think of the spread as the cost of takers paid to makers (liquidity provider) for immediate execution. As long as your strategy involves taking/crossing the book, then half spread has to be considered as a cost. Also, relying on current book-weighted mid to calculate cost does not seem very reasonable to me. You can use it as a proxy of future price, but to calculate cost you should use price that will trade, since you are never gonna execute on mid price.
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