The Science of Algorithmic Trading and Portfolio Management : [PDF Download]

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“Permanent Impact represents the information cost component. The information content, whether real or perceived, causes market participants to adjust their prices to a new perceived fair value. The rationale is that informed investors typically buy undervalued stock and sell overvalued stock.

As participants observe buy orders their perception (at least to some extent) is that the stock is undervalued and they will adjust their offer prices upwards. As participants observe sell orders their perception (again, at least to some extent) is that the stock is overvalued and they will adjust bid prices downward.

It is an unavoidable trading cost. Mathematically, we define market impact as the difference between the actual price trajectory after the order is released to the market and the price trajectory that would have occurred if the order were never released.

Regrettably, we cannot observe both price trajectories simultaneously and it is not possible to construct a controlled experiment to measure both trajectories at the same time. As a result, market impact is often referred to as the Heisenberg uncertainty principle of finance.”

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