Order Size, Book Depth, and Market Impact

Summary

This exchange discusses how the execution cost of a direct market order can change with order size. In a static limit order book, a larger market order generally consumes more of the available opposing quotes, potentially reaching less favorable prices and increasing its effective spread or impact.

The response cautions that live execution may differ from a static-book picture: market makers or other participants with priority can affect whether and how an order interacts with displayed book depth. It suggests that market impact is often described by a square-root relationship, while emphasizing that the relationship is arguable and pointing generally to the broader literature. The note supplies no data, derivation, asset-specific estimate, or conditions under which that functional form should be expected, so it is an introductory intuition rather than a calibrated execution model.

Key ideas

• In a static order book, larger market orders can consume more price levels.
• Real market structure and participant priority can change the interaction with displayed depth.
• The response identifies a square-root form as a commonly discussed market-impact relationship.
• The document provides no empirical fit or universal law for the size-impact curve.

Tags

# Relationship between order size and spread for direct market order


# Relationship between order size and spread for direct market order












Suppose that I am placing a market order directly in the order book of an exchange. For market orders, it seems quite clear that larger orders obtain larger spreads due to the fact that - without loss of generality - a large market buy order must reach further into the limit sell orders of the order book than would a smaller market order.

Assuming that this initial premise is true (and if it's not, please tell me!), what would be the nature of this relationship? Would it be linear? Quadratic? Logarithmic? Any insights would be appreciated, including links to existing research on the subject.

## Answer by quantinho (score 1, accepted)

https://quant.stackexchange.com/a/75120

In theory or when doing simulation with static orderbook your assumption is right. In general it is correct that large size orders have larger market impact. However, in real life there are other things you should take into account. Exchanges have market makers or some sort of participants who have higher priority and your market order does not necessarily reach orderbook. As for relationship, it is arguably square-root. If you look market impact you will find enough literature you decide for yourself whether that it true or not. You can refer to this link for more info.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.