Realized Spread

The realized spread differs from the effective spread in an important way: it is measured not at the moment of execution, but relative to where the price moves in the short period following the trade. The intuition is that the effective spread captures the gross revenue a liquidity provider appears to earn — the distance from execution price to midpoint — but some of that apparent revenue is immediately eroded when the price moves in the direction of the trade, reflecting that the market maker was trading against a more informed participant than anticipated. The realized spread measures what remains after this adverse price movement.

Formally, the realized spread for a sell (market maker sells to an incoming buyer) is calculated as: Realized Spread = 2 x (Execution Price - Midpoint at time T+N), where T is the trade time and N is a short interval, commonly five minutes or thirty minutes. If a market maker sells shares at $50.02 when the midpoint is $50.01, and the midpoint rises to $50.015 five minutes later, the realized half-spread is $50.02 - $50.015 = $0.005, or $0.01 on a round-trip basis. The market maker earned less than the $0.01 effective half-spread would suggest because prices moved against them immediately after the trade.

The decomposition of the effective spread into the realized spread and the adverse selection component is a fundamental concept in academic market microstructure theory, associated with foundational research by Glosten and Harris, Huang and Stoll, and subsequent researchers. The adverse selection component represents the portion of the effective spread that compensates the market maker for the risk of trading against informed counterparties — traders who know more about the stock's true value than the market maker does. Stocks with high adverse selection costs tend to have wider spreads because market makers need larger compensation to accept the risk of being picked off by informed traders.

For market structure researchers and practitioners, the realized spread serves as a measure of the true profitability of liquidity provision after accounting for information risk. A low or negative realized spread means that market makers are being systematically picked off by informed traders — prices are moving against them immediately after execution, suggesting a high proportion of informed order flow. A high realized spread relative to the effective spread suggests a healthy mix of uninformed order flow that allows liquidity providers to earn a consistent profit.

Regulatory reporting under Rule 605 includes realized spread calculations at specific intervals, giving researchers and the SEC data to monitor trends in liquidity provider profitability and adverse selection costs across different market conditions, security types, and execution venues. Changes in realized spread patterns over time can signal shifts in the informational composition of order flow or in the competitive dynamics of liquidity provision.