Why price impact matters when you trade large orders

When you buy a few shares of a large company, the price hardly moves. When a fund buys lakhs of shares, it often does. That movement is called price impact. This page explains what it is, why it happens and how traders try to limit it.

Quick answer

Price impact is the change in a share's price caused by your own buying or selling. A buy order large enough to use up the shares offered at the best price pushes the price higher, and a large sell order pushes it lower. The bigger the order compared with available liquidity, the bigger the impact. It is a hidden trading cost, especially for large investors.

Key takeaways

• It is the price change caused by your own trade.
• Large orders in thinly traded shares face the most.
• It is a hidden cost on top of brokerage and taxes.
• Splitting orders over time can reduce it.
• Part of the impact can be temporary and part lasting.

What is price impact?

At any moment, only a certain number of shares are offered at each price in the order book. If your buy order is bigger than what is available at the best price, it takes those shares and then moves to the next, higher price. The average price you pay rises.

The same happens in reverse when you sell. Your own order changes the price you get, which is why this effect is often called the cost of demanding immediate liquidity.

A simple example

If you place a market order to buy 2,000 shares, you buy 500 at Rs 100.00, 800 at Rs 100.10 and 700 at Rs 100.25. Your average price is about Rs 100.15. The last trade happened at Rs 100.25, so the market price itself has moved up.

For someone buying just 100 shares, there is no impact at all, since enough shares are available at Rs 100.00.

Temporary and lasting impact

Some of the price move is temporary. After a large order is done, new sellers may come in and the price may drift back. This is the cost of needing liquidity quickly.

Some of the move may last. If the market reads the large order as a sign of new information, the price may stay at the new level. Large investors try to avoid signalling their intentions for this reason.

What affects price impact?

The main factors are order size compared with normal trading volume, the depth of the order book and how volatile the share is. Large company shares with heavy daily volume usually have low impact. Small company shares with thin trading can see big impact even on modest orders.

Timing also matters. Trading during busy periods, when more orders are present, usually means lower impact than trading in quiet periods.

How to reduce price impact

Large investors split orders into smaller pieces over time, using methods like VWAP or TWAP. They may also use the exchange's block deal window for very large trades.

For individual investors, using limit orders, checking market depth before trading and avoiding very illiquid shares can help. In short, this effect is the cost of your trade moving the market, and size and liquidity decide how big it is.

Frequently Asked Questions