# Effective spread

Effective spread is twice the distance between a trade’s execution price and the prevailing bid-ask midpoint, expressed per share or as a percentage of that midpoint.

## What it means

A stock can trade at a price different from the best displayed bid or ask. Effective spread measures the executed price’s distance from the bid-ask midpoint, doubled to express a full-spread equivalent. It uses an actual fill and a midpoint observed when the trade occurs, so it is generally a *post-trade* measure.

For a customer buy, a price above the midpoint represents a positive effective spread. For a customer sell, a price below the midpoint does the same. A trade priced favorably beyond the midpoint can have a negative *signed* effective spread; an absolute-value version would report a positive distance instead. State which convention you use.

## How it is calculated

For a signed, per-share effective spread, use `effective spread = 2 × trade direction × (execution price − midpoint)`, where:

- **Trade direction** is +1 for a buy and −1 for a sell from the perspective of the order being measured.
- **Execution price** is the actual fill price, in US$ per share.
- **Midpoint** is `(best bid + best ask) / 2` at the relevant time, in US$ per share. Use a consistent quote and trade timestamp.

The result is in US$ per share. To express it as a percentage, use `effective spread (%) = (effective spread / midpoint) × 100`. If an order receives multiple fills, calculate each fill’s effective spread against its corresponding midpoint and take a share-weighted average. A clearly labeled absolute-value measure instead uses `2 × |execution price − midpoint|` and does not preserve whether the fill was favorable or unfavorable to the customer.

## Worked example

Suppose, hypothetically, the best bid for a stock is US$49.95 and the best ask is US$50.05 when a customer buy of 100 shares executes at US$50.02.

1. Find the midpoint: `(US$49.95 + US$50.05) / 2 = US$50.00`.
2. Subtract the midpoint from the buy fill: `US$50.02 − US$50.00 = US$0.02` per share.
3. Double that distance: `2 × US$0.02 = US$0.04` per share. The effective spread is `US$0.04 / US$50.00 × 100 = 0.08%`, or 8 basis points.
4. Distinguish the spread measure from the order’s midpoint-relative dollar cost: `100 × US$0.02 = US$2.00`. Do not double this US$2.00; doubling belongs to the full-spread convention, not to the cash difference between this fill and the midpoint.

The displayed, or *quoted*, spread was `US$50.05 − US$49.95 = US$0.10`. The effective spread is smaller because this hypothetical buy filled below the displayed ask. A different fill or quote would produce a different result.

## Why it matters before you trade

You cannot know an order’s actual effective spread until it fills. Before placing an order, however, you can examine the quoted spread and consider how order size, liquidity, price limits, and timing may affect the eventual fill. An estimated spread is a planning input, not a measurement of a future execution.

Effective spread is one part of execution-cost analysis. It does not by itself capture commissions, changes in price between deciding to trade and placing the order, or the full cost of an order that fills only partly. Comparing fills also requires care: midpoint prices and market conditions can differ across trades.

## How PreTrAIde uses it

PreTrAIde does not claim to calculate an actual effective spread: it never receives, transmits, or executes orders. Its pre-trade analysis instead estimates the bid-ask spread using a liquidity-tier model with a volatility uplift and a one-tick floor. It also estimates participation in daily volume and market impact when assessing a proposed stock basket.

Those estimates can inform a check before the user places an order with their own broker. They are not fill prices, and an estimated bid-ask spread should not be labeled a measured effective spread. PreTrAIde’s GO, NO-GO, and MODIFY verdicts are decision support, not trade recommendations.

## Common mistakes

- **Confusing effective and quoted spread:** Quoted spread is ask minus bid; effective spread uses the actual execution price and contemporaneous midpoint.
- **Confusing effective and realized spread:** Realized spread uses a later midpoint and answers a different question about the trade after the market has had time to move.
- **Double-counting dollars:** The factor of two creates a full-spread equivalent. A single fill’s midpoint-relative cash difference is shares multiplied by its one-sided price difference.
- **Ignoring timing or direction:** A stale midpoint, mismatched quotes, or an incorrect buy/sell sign can make the result misleading.

---
Source: https://pretraide.com/glossary/effective-spread