# Liquidity tier

Liquidity tier is a category based on a stock’s average daily dollar trading volume, used to assign a baseline estimate of its bid-ask spread.

## What it means

Stocks do not all trade with the same ease or at the same cost. A liquidity-tier model sorts them into bands according to average daily dollar volume: the average value of shares traded per day over a chosen period. Each band is assigned a **baseline expected bid-ask spread**, often expressed in basis points (bps). One basis point is 0.01%.

Generally, a higher-volume band gets a narrower baseline spread than a lower-volume band. That is a modeling assumption, not a promise about any particular quote or fill. Tier cutoffs and assigned spreads depend on the model; there is no universal set of bands.

## How it is calculated

A simple method first measures daily dollar volume, averages it, then applies a band-to-spread lookup:

`DDV_d = P_d × V_d; ADDV = (Σ DDV_d) / N; baseline spread (bps) = tier_lookup(ADDV)`

- `DDV_d` is dollar volume on trading day `d`, measured in US$ for a US stock.
- `P_d` is the stock price in US$ per share on day `d`; the daily closing price can be used for an approximation.
- `V_d` is shares traded on day `d`, measured in shares.
- `ADDV` is average daily dollar volume, in US$ per trading day.
- `N` is the number of trading days in the averaging window; `Σ` means add the daily values across that window.
- `tier_lookup` assigns the ADDV to a model-defined band and returns that band’s baseline expected full bid-ask spread in bps. The lookup is an estimate, not an observed quote.

A price adjustment may be needed when historical data include a stock split: prices and volumes must be on a consistent basis. A single unusual trading day can also distort a short averaging window.

## Worked example

The following cutoffs and spreads are **hypothetical**, not PreTrAIde settings or market-wide standards:

| Average daily dollar volume | Hypothetical baseline full spread |
| --- | ---: |
| Under US$1 million/day | 40 bps |
| US$1 million to under US$10 million/day | 20 bps |
| US$10 million/day or more | 10 bps |

Suppose a US stock has a hypothetical average closing price of US$50 per share and trades 100,000 shares each day for 20 trading days.

1. Daily dollar volume is `US$50/share × 100,000 shares = US$5 million`.
2. Because each of the 20 days is identical in this example, ADDV is `US$5 million/day`.
3. US$5 million/day falls in the middle band, giving a baseline estimated **full** spread of 20 bps, or 0.20% of the midpoint price.
4. At a hypothetical US$50 midpoint, that full spread corresponds to `US$50 × 0.002 = US$0.10 per share`: approximately US$49.95 bid and US$50.05 ask if the quote is centered on the midpoint. This is an illustration, not a live quote.

## Why it matters before you trade

A wider expected spread means a larger potential cost of crossing from the bid to the ask. If the spread is symmetric around the midpoint, a single immediate buy at the ask starts half a spread above that midpoint; a single immediate sell at the bid starts half a spread below it. Actual execution cost also depends on order size, market depth, market impact and changing quotes.

Average dollar volume puts a stock’s trading activity in monetary terms, making bands more comparable across stocks with different share prices. But a tier cannot show whether enough shares are available at the best quote for a particular order. Pre-trade analysis therefore needs to consider the proposed order as well as the stock’s typical activity.

## How PreTrAIde uses it

PreTrAIde estimates bid-ask spread using a liquidity-tier model with a volatility uplift and a one-tick floor. Its quantitative layer also assesses participation in daily volume, market impact and liquidity. These estimates help inform its per-stock and basket pre-trade analysis; they are not guaranteed execution prices. PreTrAIde does not receive, transmit or execute orders.

## Common mistakes

- **Treating the band as a live quote.** The actual spread can change throughout the trading day.
- **Confusing full spread with half-spread.** A quoted full spread of 20 bps is 10 bps from midpoint to either side if centered.
- **Assuming high volume eliminates market impact.** A large order can still move the price or consume available depth.
- **Comparing bands without checking units.** US$5 million per day is dollar volume, not 5 million shares per day.
- **Assuming the example cutoffs are universal.** Different models can define different windows, thresholds and baseline spreads.

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Source: https://pretraide.com/glossary/liquidity-tier