What Is Price Impact?
Price impact refers to the relationship between an incoming trade order and the resulting change in the price of the asset being traded.
It describes how the execution of a trade affects the market price.
Impact of Trades on Asset Prices
When a buy trade occurs, it can push the price of the asset higher by consuming available sell orders in the order book.
Conversely, sell trades can cause the price to decrease by depleting buy orders.
The magnitude of the price movement resulting from a trade depends largely on the liquidity of the trading pair involved.
Trading pairs with higher liquidity tend to experience smaller price impacts compared to those with lower trading volumes.
Navigating Price Impact
Traders, especially those operating in markets with limited liquidity or executing large trades, need to consider the potential price impact of their orders.
Subsequent buy trades by the same trader are likely to be more expensive on average due to their impact on the market.
Monitoring and managing price impact is a significant area of focus for trading firms.
Extensive research is being conducted to understand the relationship between trade size and its impact on asset prices, as well as the time it takes for the full effect of a trade to be reflected in the market.