Spread, slippage, and liquidity
When you buy shares, ETFs or coins, you pay more than the fee on your statement. Spread and slippage cost you money without showing up anywhere as costs.
Learning objective: After this lesson you'll recognize spread and slippage as costs that don't appear on any statement.
When you want to buy something on the stock market, you always see two prices. One you can buy at right away, and a slightly lower one you can sell at right away. The gap between them is called the spread.
An example with numbers
An example: Lena wants to buy a share. The app shows €99.90 to sell and €100.10 to buy. She buys 50 shares at €100.10 and realizes a few seconds later that she made a typo. If she sells straight away, she only gets €99.90 per share. The price hasn't moved, and still €10 is gone. Nothing about it appears on her statement.
Once, you barely notice it. But if you buy and sell a few times every week, you pay this gap every time. Over a year it quickly becomes the biggest cost item, bigger than the fee for the order itself.
What slippage is
Slippage is something else. You see €100, tap buy and in the end get the share for €100.30. Between your click and the fill, the price moved. That happens mainly when the market moves fast, when you buy a large amount or when hardly anyone is trading.
Liquidity
Both depend on how much is going on in a market. Experts call this liquidity. With a large world market ETF in the morning, the two prices are often only a few cents apart. With a small share in the evening or a coin hardly anyone trades, it can be several percent. If you put €1,000 into something like that, you're already €30 or €40 down right after buying.
What you can take from this: buy and sell when a lot is being traded if you can, so for shares during normal exchange hours. And before buying, look at both prices, not just the one the app shows in big letters.
Behind the spread there's usually a market maker. That's a dealer who constantly quotes both prices so you can buy and sell at any time. They earn from the gap between the prices. At the same time they carry a risk: sometimes they trade with someone who knows more than they do, for example shortly before important news. That's why the spread widens when prices swing a lot (volatility), when little is traded and around news.
Measuring what an order cost
You can measure how expensive an order really was. Take the midpoint between the best buying price and the best selling price at the moment of your order and compare it with the price you actually paid. An example: the best selling price is €99.90, the best buying price €100.10, so the midpoint is €100.00. If you get your shares for €100.12, the order cost you €0.12 per share, on top of any fee. That figure is the most honest yardstick when you compare providers.
Large orders
With large orders there's one more thing. You buy so much that the cheapest offers aren't enough and you have to take more expensive ones too. This effect grows more slowly than the order size, roughly with the square root of the ratio between order size and usual daily turnover. For normal amounts in well known shares and ETFs it doesn't matter. For small caps and coins with little volume, though, it can cost more than all the listed fees put together.
Summary
- The spread costs you money on every purchase but appears on no statement.
- When little is traded or prices swing a lot, the gap gets bigger.
- With small shares and rarely traded coins, these hidden costs are often higher than all fees.
Did you get it?
Lena buys at €100.10 and immediately sells at €99.90. Where did the money go?
It's the spread. You pay it on every immediate purchase and sale, even if the price doesn't move at all.
When does the gap between the two prices get bigger?
When prices swing a lot, when little is traded and around important news.
How do you find out what an order really cost you?
You compare your buying price with the midpoint between the best buying and the best selling price at the moment of your order.
Check your understanding
Your task
A stock shows $50.20 to buy and $49.80 to sell. You buy 40 shares and sell right away. Calculate how much you lose to the spread alone, and how much that adds up to over a year if you do it every week (52 times).
Sources and further reading
- Glosten and Milgrom's original 1985 study on how the spread arises from the market maker's adverse-selection risk. View source ↗