What it means
In share markets, there is always a best bid, which is the highest price someone will pay, and a best ask, which is the lowest price someone will sell for. An order to buy at the market would normally be filled at the ask.
If it is filled at a lower price, the investor has received price improvement. It can arise in several ways.
A market maker, who is a firm that stands ready to buy and sell, may offer a slightly better price to win the order. Or an order may be matched inside the spread, which is the gap between the bid and the ask, in a private venue or an auction.
The amount is usually small, often a fraction of a cent per share. But it adds up for large orders and for active traders, and it is one of the measures regulators and brokers use to judge execution quality.
Some brokers publish statistics on how often and by how much their customers' orders receive it. Price improvement is distinct from a limit order filled at its limit price.
A limit order says the investor will not pay more than a given price, so if the order is filled at a lower price, the difference is improvement. The investor never gets a worse price than the limit, but may get a better one.
There are things to be aware of. Brokers may route orders to venues that pay for order flow, and there is debate about whether this always serves customers.
Compare the broker's execution quality reports, not just the commission, and check the total cost of trading. For a business that trades securities or currencies, such as a corporate treasury, price improvement is part of the real cost of dealing.
Tracking the execution price against the quote at the time of the order, known as slippage when it goes the wrong way, shows how well the dealing desk performs.
In practice
Real-world examples.
Example
A retail investor sells 300 shares when the best bid is $45.10 and receives $45.12 a share from a market maker. The improvement is $0.02 a share, so $6 in total. The broker reports the improvement on the trade confirmation. She keeps the confirmations to compare brokers at the end of the year.
Example
A corporate treasury desk buys a currency with a quoted rate that is slightly higher than the rate it actually receives from a dealer. On a $2,000,000 purchase, the better rate saves $400. The treasurer compares dealer prices regularly to keep the pressure on. A formal record of quotes also helps when auditors ask how prices were obtained.
Example
A trader sends a limit order to buy at $12.50 when the market ask is $12.45. The order is filled at $12.45, so she has paid $0.05 less than her limit. Across 10,000 shares, the benefit is $500. She notes that the limit order protected her from paying more, while the market delivered a better price.
Formula
Calculation
Price improvement per share = quoted price - execution price (for a buy); total improvement = improvement per share x shares.
An investor places a market order to buy 1,000 shares when the best ask is $20.05. The order is filled at $20.03, so improvement is $20.05 - $20.03 = $0.02 per share. Total improvement = $0.02 x 1,000 = $20. Total cost is 1,000 x $20.03 = $20,030 instead of $20,050. Expressed as a rate, $0.02 on a $20.05 price is about 0.1%, which looks small but is meaningful for someone who trades often. An investor who makes 200 similar trades a year would save about $4,000.Case study
Seen in the real world.
Castlegate Securities is a fictional broker used here to illustrate the idea. Its customers placed about 40,000 orders a month, and the compliance team reviewed execution quality each quarter.
The review showed that 58% of orders received price improvement averaging $0.012 per share. On the typical order of 200 shares, that was about $2.40 per improved order, and over a year it added up to a meaningful saving for customers.
The illustrative broker published the results in its customer reports and used them to negotiate better terms with its execution venues. The figures showed customers that low commissions were not the whole story.
Watch out
Common mistakes.
- Assuming the best quote is always what you pay. Orders are often filled at slightly better or worse prices.
- Judging a broker on commission alone. Execution quality can matter as much for active traders.
- Confusing improvement with a limit order that is simply filled. If the fill is at your limit, there is no improvement.
Questions
People also ask.
How is price improvement measured?
It compares the execution price with the best quoted price at the moment the order was received.
Does it happen on every trade?
No, many orders are filled exactly at the quote, and some in fast markets are filled at worse prices. Price improvement is more common in liquid shares with narrow spreads.
Why does it matter?
Small gains per share add up across many trades and large orders, which lowers the true cost of trading.
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