What Is Price Improvement?
Price improvement involves achieving a trade at a better price than the price quoted at the time an order was placed. It would mean finding a higher bid price if you are selling an asset, or a lower ask price if you are buying an asset.
While many brokers tout their ability to get price improvement for their customers' orders, price improvement is always an opportunity and never a guarantee.
- Price improvement is when a securities order is filled at a better price than quoted.
- Price improvement is more likely to occur in highly-liquid, actively-traded securities.
- Many brokers use their purported ability to gain price improvement for their clients in marketing materials, but these claims are never guarantees.
Understanding Price Improvement
Price improvement occurs when an order is filled at a more favorable price than anticipated. In the case of a limit order, for instance, with a limit price to buy XYZ shares at $10.00, if a broker is able to fill the order for $9.98 instead, it would indicate a 2-cents price improvement.
The root causes of price improvements aren't always completely clear, but they often have to do with simple changes in supply and demand in the market. Other times, the changes arise from the pricing differences that exist from one market to the next and depend on whether the brokerage firm is buying or selling shares on behalf of itself.
Although many brokerages will claim they offer price improvement to clients with lines like "fighting for that last $0.01," there is no guarantee this will actually happen, no matter what brokerage is making the claim.
Price Improvement and National Best Bid and Offer
Understanding the National Best Bid and Offer (NBBO) is essential to understanding the nature of price improvement. Under SEC rules, the NBBO consists of the highest displayed buy and lowest sell prices among the various exchanges trading a security. Exchanges and liquidity providers can route orders to the exchange with the best quote represented in the NBBO. Alternatively, it can match or improve those prices and execute on their own market venue.
In equity markets, various liquidity providers may choose not to display their orders to avoid revealing their trading strategy. In such a case, all available liquidity may not be displayed in the NBBO. To accommodate those traders, exchanges may allow them to post their orders anonymously, away from the publicly-displayed quotes. Accessing this better-priced, non-displayed liquidity creates opportunities for liquidity providers to provide better value at execution.
Another way that liquidity providers may improve a price on an order when trading as a market maker would be to match the NBBO price for more shares than the displayed size available at the NBBO. This method is often referred to as liquidity enhancement.
Example of Price Improvement
Price improvement on an individual transaction is calculated based on the difference between the execution price and the NBBO at the time of the order. The amount of price improvement per share may be less than the minimum quotation price increment (typically, one cent). For example, consider a trader that places an order to buy 1,000 shares of XYZ stock currently quoted at $25.30 per share.
If the order is executed at $25.29, then the trader gets a $0.01 per share of price improvement, resulting in a total savings of $10.00 (1,000 shares × $0.01).