Market Impact
The effect that executing a large trade has on the market price of the security being bought or sold, causing the price to move against the trader.
What is Market Impact?
Market impact is the change in the price of a security caused by the act of trading it. When a large buy order enters the market, it consumes available sell orders at the current price, pushing the price higher for subsequent portions of the order. Similarly, a large sell order drives the price lower. Market impact is a form of transaction cost that is directly proportional to order size and inversely proportional to market liquidity. Institutional investors and algorithmic traders use execution strategies such as volume-weighted average price (VWAP) algorithms, time-sliced orders, and dark pools to break up large orders and minimize market impact. Unlike brokerage commissions, market impact cost is implicit and often invisible but can be substantial for large trades.
Example
A mutual fund needs to sell $500 million of a mid-cap stock. If executed as a single order, the selling pressure would drive the stock price down significantly before the order is complete, generating large market impact cost. Instead, the fund uses a VWAP algorithm to slice the order into small pieces executed over several days, minimizing price depression.
Source: CFA Institute — Trading, Monitoring, and Rebalancing