Skip to content
DP
Liquidity Riskintermediate

Effective and Quoted Spread

The quoted spread is the posted gap, Pask−PbidP_{\text{ask}} - P_{\text{bid}}. But many trades execute at better prices than the quote, inside the spread, or worse, beyond it, so the quoted spread overstates or understates the true cost. The effective spread measures the cost actually paid. It is twice the distance between the execution price and the mid-quote at the time of the trade, Effective Spread=2 ∣Pexec−Pmid∣\text{Effective Spread} = 2\,|P_{\text{exec}} - P_{\text{mid}}|. Because it uses the price the trader really got, the effective spread is the more honest gauge of trading cost. When trades routinely execute inside the quote (price improvement), the effective spread is smaller than the quoted spread; in fast, one-sided markets it can be larger.

Try it yourself

Stock liquidity — measuring tightness, depth and price impact

Is this stock liquid? Read the spread and the Amihud ratio.

A tight spread is cheap to round-trip and a low Amihud ratio means a dollar of trading barely moves the price. Both point to a liquid name. The Amihud ratio is the one to watch: higher Amihud = more price impact per dollar = LESS liquid.

Quoted spread %
0.08%
= US$0.04 / mid US$50.00
Amihud ILLIQ (×10⁶)
1.60e-5Liquid
raw 1.60e-11 per US$ traded
Spread costs and turnover (% of mid-price / float)
Quoted spread0.08%Effective spread0.04%Turnover0.50%
Mid-price Pₘᵢ𝒹 = (ask + bid)/2US$50.00
Quoted spread Pₐₛₖ − P_bidUS$0.04 (0.08%)
Effective spread 2·|Pₑₓₑ𝒸 − Pₘᵢ𝒹|US$0.02 (0.04%)
Turnover Volume / Shares out.0.50% / day
Daily dollar volume P · VolumeUS$500100000
Amihud ILLIQ |Rₜ| / (P·Volume)1.60e-11 (×10⁶ = 1.60e-5)
A tight spread of 0.08% and a low Amihud ratio mark this as a liquid name: a dollar of trading barely nudges the price.
Spread % 0.08%Turnover 0.50%Amihud verdict Liquid
Try this. Load the small-cap, then drag daily volume up toward the blue-chip level. Watch the Amihud ratio collapse: same price move, far more dollars traded, so each dollar moves the price less. Then drop the daily |return| and notice the spread is unaffected — spread (tightness) and Amihud (price impact) are separate dimensions of liquidity.
Reflect: two stocks share the same quoted spread. Which measure would still tell you they differ in how much a large order moves the price?

Why it matters

The quoted spread is the sticker price; the effective spread is what you actually paid at the register. Sometimes you get a discount because a hidden buyer steps in and fills you inside the quote. Sometimes, in a fast market, you pay more than the sticker because the quote moved before your order arrived. To know the real cost of trading, you compare the price you got against the mid-quote that prevailed the instant you traded, then double it to put it on the same round-trip footing as the quoted spread.

Formulas

Quoted spread
Quoted Spread  =  Pask−Pbid\text{Quoted Spread} \;=\; P_{\text{ask}} - P_{\text{bid}}
The posted cost of a round trip, before considering where trades actually execute.
Effective spread
Effective Spread  =  2 ∣Pexec−Pmid∣\text{Effective Spread} \;=\; 2 \,\bigl| P_{\text{exec}} - P_{\text{mid}} \bigr|
Twice the absolute distance from the execution price to the prevailing mid-quote. The factor of 2 scales the one-side cost up to a full round-trip basis, comparable to the quoted spread.

Worked examples

Scenario

A stock is quoted bid 49.95 / ask 50.05 (mid 50.00, quoted spread 0.10). A buy order fills at 50.02. What is the effective spread, and what does it reveal?

Solution

Effective spread = 2 × |50.02 − 50.00| = 2 × 0.02 = 0.04. The trade executed inside the quoted 0.10 spread, so the trader received price improvement: the effective cost of 0.04 is less than half the quoted 0.10. This is common when hidden or competing liquidity fills orders better than the posted quote. Using the quoted spread alone would have overstated the true trading cost by more than double.

Common mistakes

  • ✗The quoted spread always equals the cost actually paid. Trades often execute inside or outside the quote, so the effective spread, based on the real fill price, is the accurate cost.
  • ✗The effective spread is always smaller than the quoted spread. Price improvement makes it smaller, but in fast, one-sided markets where quotes move before the order arrives, the effective spread can exceed the quoted spread.
  • ✗You should not double the distance from the mid. The effective spread multiplies the one-side distance by two so it is on a full round-trip basis, directly comparable to the quoted spread.
  • ✗A mid-quote is the same as the last trade price. The mid is the average of the prevailing bid and ask at the moment of the trade; the last trade can sit at the bid, the ask, or in between.

Revision bullets

  • •Quoted spread = posted ask minus bid
  • •Effective spread = 2 × |execution price − mid-quote|
  • •Effective spread uses the price actually obtained
  • •Price improvement makes the effective spread smaller than the quoted
  • •The factor of 2 puts the one-side cost on a round-trip basis

Quick check

A stock’s mid-quote is 80.00. A market buy fills at 80.03. The effective spread is

When trades routinely execute inside the posted quote (price improvement), the effective spread is

Connected topics

Stock LiquidityLiquidity RiskBid-Ask SpreadMarket Depth

Sources

  1. Bessembinder (2003)
    Bessembinder, H. "Issues in Assessing Trade Execution Costs." Journal of Financial Markets, 6(3), 233–257, 2003.
    Discusses effective and quoted spreads as execution-cost measures and the role of price improvement.
  2. Jorion, FRM Handbook (2011)
    Jorion, P. Financial Risk Manager Handbook. 6th ed. GARP / Wiley, 2011.
    Distinguishes the quoted from the effective spread as liquidity cost measures.
How to cite this page
Dr. Phil's Quant Lab. (2026). Effective and Quoted Spread. Derivatives Atlas. https://phucnguyenvan.com/concept/frm-effective-quoted-spread
← Back to the atlasSee in the network →