Definition
Implementation Shortfall
Implementation shortfall is the difference between the price of a stock when the decision to trade was made (the arrival or decision price) and the actual average price achieved, including all explicit and implicit costs.
Also called arrival-price strategy, an implementation shortfall algo seeks to minimise total trading cost rather than beat a volume benchmark. It weighs the market impact of trading quickly against the timing risk of price drift while the order is worked, and front-loads execution when urgency or volatility is high.
For Indian institutions, implementation shortfall is the most economically honest benchmark because it captures opportunity cost, slippage and commissions together. It is favoured by managers with a strong short-term view who care about the price at the moment of decision, not the day's average.
Related terms
- Execution AlgorithmAn execution algorithm is a program that works a large parent order into many smaller child orders over time to minimise market impact and achieve a target benchmark such as VWAP or the arrival price.
- Arrival PriceArrival price is the prevailing market price at the moment a trading decision is made and the order arrives at the desk, used as the reference point for measuring implementation shortfall.
- Market ImpactMarket impact is the adverse price movement caused by the act of trading itself, where a large buy pushes the price up and a large sell pushes it down as the order consumes available liquidity.
- SlippageSlippage is the difference between the expected price of a trade and the price at which it is actually executed, arising from market movement, spread and limited liquidity between order placement and fill.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.