thantheirownquotes,andthishastheeffectofreducingthe
bid-askspread.OntheNASDAQ,limitordersdonotaffect
the bid-ask quotes, and are executed only if prices move
againstthelimit.Onewouldexpectlargerbid-askspreadsas
a consequence.
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In 2000, the New York Stock Exchange abandoned its
historicalpracticeofquotingpricesinfractions(1/8,1/4,etc.)
and shifted to decimal prices. Since you can get finer
gradationsofpricesindecimals,itwashypothesizedthatthis
shouldleadtosmallerbid-askspreads.Studiessincetheshift
indicate that therehas been a reduction in spreads on the
smaller,less liquidstocksbutnodiscernibleimpactonthe
more liquid listings.
Price Impact
Mostinvestorsassumethattradingcostsbecomesmalleras
portfolios become larger. While this is truefor brokerage
commissions, it is not always the case for the other
componentsoftradingcosts.Thereisonecomponentwhere
largerinvestorsbearmoresubstantial coststhandosmaller
investors,andthatisintheimpactthattradinghasonprices.
Ifthebasicideabehindsuccessfulinvestingistobuylowand
sellhigh,pushingthepriceupasyoubuyandthendownas
you sell reduces the profits from investing.
Why Is There a Price Impact?
Therearetwo reasonsfortheprice impactwheninvestors
trade.Thefirstisthatmarketsarenotcompletelyliquid.A
large trade can createan imbalance between buy and sell