How is the average effective spread determined?

The average effective spread is determined by calculating the mean effective spread over all transactions in a specific stock. This method provides a comprehensive view of the transaction costs that investors experience when buying and selling the stock. The effective spread takes into account the actual execution prices relative to the midpoint of the bid-ask spread, which reflects the cost incurred by an investor for trading.

By averaging the effective spreads across multiple transactions, the average effective spread gives a more accurate representation of the trading costs rather than just looking at daily bid-ask differences or specific trades. This approach captures variations in trading conditions and provides insights into the liquidity and efficiency of the market for that stock over time.

Using other methods, such as simply averaging bid-ask differences or calculating total spreads divided by the number of trades, does not account for the specific execution prices and how they might differ from the midpoint. Additionally, just considering the highest and lowest spreads of the day fails to reflect the overall trading activity and costs involved.