Q: What is market impact and why should I avoid it?
A: Market impact is the price movement imposed by an executed trade (upward when buying and downward when selling). Increased market impact from clearing multiple levels of the book, results in a less favorable price for the executing trader and may manipulate the market outside of normal or “fair” price range as measured by other markets that include the same asset or pair. This so-called “market impact cost” is at best an unfavorable price movement against the trader (also called “slippage”) and at worst may constitute market manipulation when the realized market impact is outside local market norms or significantly outside relative fair price.
Sophisticated traders seek to minimize market impact in order to obtain better prices for their trades and not signal their intentions to the market. Strategies for mitigating market impact include using smaller orders, spacing orders out through time, varying order sizing and timing, or using algorithmic strategies such as VWAP or TWAP to spread the desired buying or selling volume out to minimize adverse price impact.
Note that a trade or series of trades that cause large market impacts may be found to be in violation of exchange policies against market manipulation. Adverse market impact is easy to mitigate or avoid completely with a little care. The trader gets a better price, and the market functions more smoothly for everyone.
