Price Improvement
Price improvement refers to the execution of an order at a price better than the best quoted price in the market at the time the order was received—for a buy order, this means executing below the national best offer (NBO), and for a sell order, executing above the national best bid (NBB). Price improvement is a key metric of execution quality and a competitive differentiator among broker-dealers and electronic venues.
Key takeaways
- Price improvement is measured in dollars per share (or basis points) as the difference between the executed price and the NBBO at the time of order submission.
- Retail broker-dealers frequently advertise price improvement as a benefit of their routing practices, though the metric can be misleadingly compared to wide quoted spreads rather than economically meaningful benchmarks.
- Payment for order flow (PFOF) arrangements between broker-dealers and market makers are justified by the market makers as enabling them to provide price improvement to retail orders.
- Internalization of retail order flow allows market makers to provide sub-penny price improvement (e.g., $0.001) while still executing at prices significantly less favorable than institutional block prices.
- SEC Rule 605 requires broker-dealers to publish monthly execution quality statistics including price improvement rates, enabling investors to compare execution quality across brokers.
Explanation
Price improvement in its simplest form represents the savings realized when an order executes at a price better than the currently quoted best price in the market. For a retail investor submitting a market order to buy 100 shares when the national best offer is $50.00, execution at $49.97 represents $0.03 per share × 100 shares = $3.00 of price improvement. Aggregated across millions of retail orders, price improvement statistics are frequently cited as evidence that a broker's routing practices benefit customers.
The mechanism by which market makers provide price improvement is tied to their ability to identify retail order flow as likely uninformed. Academic research consistently shows that retail market orders carry less adverse selection risk than institutional orders—they are less likely to reflect private information about the asset's value. Market makers who internalize retail flow can therefore offer slightly better prices than the displayed NBBO while still earning a profit on the round-trip, as the spread between their execution price and fair value more than compensates for any price improvement granted.
The relationship between price improvement and the payment for order flow (PFOF) controversy is central to ongoing regulatory debate in U.S. equity markets. Market makers such as Citadel Securities and Virtu Financial pay broker-dealers for the right to execute retail orders, a practice known as PFOF. The justification offered by market makers is that their execution quality—including price improvement—is superior to what would be obtained by routing orders directly to exchanges. Critics argue that the same retail order flow, if submitted directly to exchanges with competitive limit orders, would receive prices equal to or better than the PFOF-enabled executions, and that the PFOF payments capture economic value that should accrue to retail investors.
Measuring price improvement fairly requires careful benchmark selection. If the NBBO spread is $0.10 (bid $50.00, ask $50.10) and a market maker offers price improvement of $0.01 (executing a buy order at $50.09), the improvement sounds modest in absolute terms but represents 10% of the spread. However, if institutional block trades in the same stock regularly execute at or near the midpoint ($50.05), the retail investor receiving $50.09 is still paying $0.04 above midpoint—not necessarily receiving the best possible execution. SEC Rule 605 statistics are published at the individual order size tier level, enabling more nuanced analysis, but the benchmarking methodology remains contested.
For hedge funds and institutional investors, price improvement is analyzed differently than for retail investors. Institutional orders are large enough to move markets, so 'price improvement' relative to the NBBO at order submission is an imperfect metric—the NBBO at the time of submission may already reflect the market's awareness of the impending order. Implementation shortfall analysis, which measures the gap between the decision price (the prevailing market price when the investment decision was made) and the average execution price across the entire order, is the more appropriate metric for institutional execution quality.
Formula
Price Improvement (Buy Order) = NBBO Ask - Execution Price; Price Improvement (Sell Order) = Execution Price - NBBO Bid
Example
A retail investor places a market order to sell 500 shares of a stock currently quoted at $100.00 bid / $100.10 ask (NBBO spread = $0.10). Under conventional execution at the NBB, the investor would receive $100.00 per share = $50,000 total. Instead, the broker routes the order to a market maker who executes at $100.04—$0.04 above the NBBO bid. Price improvement = $0.04 × 500 shares = $20. The market maker simultaneously hedges at the $100.00 bid level, earning $0.04 on the buy side minus the $0.04 paid in price improvement = $0 net on this trade. However, the market maker's edge comes from the statistical analysis of thousands of retail orders: on average, the post-trade price is $0.01-0.02 away from the execution price (informed traders represent a low fraction), allowing the maker to earn a net positive after paying price improvement.
Related terms
Banging The Close Equity High Frequency Trading Implementation Shortfall Many To Many Trading Market Maker Market Order Marking The Close Payment For Order Flow Quote Stuffing Stock