What is 'Implementation Shortfall'

In trading terms, an implementation shortfall is the difference between the prevailing price or value when a buy or sell decision is made with regard to a security and the final execution price or value after taking into consideration all commissions, fees and taxes. As such, implementation shortfall is the sum of execution costs and the opportunity cost incurred in case of adverse market movement between the time of the trading decision and order execution.

BREAKING DOWN 'Implementation Shortfall'

In order to maximize the potential for profit, investors aim to keep implementation shortfall as low as possible. Investors have been helped in this endeavor over the past two decades by developments such as discount brokerages, online trading and access to real-time quotes and information. Implementation shortfall is an inevitable aspect of trading, whether it be stocks, forex, or futures. Slippage is when you get a different price than expected on an entry or exit from a trade.

Example of Implementation Shortfall

If the bid-ask spread in a stock is $49.36/$49.37, and a trader places a market order to buy 500 shares, the trader may expect it to fill at $49.37. However, in the fraction of a second it takes for your order to reach the exchange, something may change or perhaps the traders's quote is slightly delayed. The price the trader actually gets may be $49.40. The $0.03 difference between their expected price of $49.37 and the $49.40 price they actually end up buying at is the implementation shortfall.

Order Types and Implementation Shortfall

Implementation shortfalls often occur when a trader uses market orders to buy or sell a position. To help eliminate or reduce it, traders use limit orders instead of market orders. A limit order only fills at the price you want, or better. Unlike a market order, it won't fill at a worse price. Using a limit order is an easy way to avoid implementation shortfall, but it's not always the best option.

When entering a position, traders will often use limit orders and stop limit orders. With these order types, if you can't get the price you want, then you simply don't trade. Sometimes using a limit order will result in missing a lucrative opportunity, but such risks are often offset by avoiding implementation shortfall. A market order assures you get into the trade, but there is a possibility you will do so at a higher price than expected. Traders should plan their trades, so they can use limit or stop limit orders to enter positions.

When exiting a position, a trader typically has less control than when entering a trade. Thus, it may be necessary to use a market orders to get out of a position quickly if the market is in a volatile mood. Limit orders should be used in more favorable conditions.

 

 

 

RELATED TERMS
  1. Interest Shortfall

    An interest shortfall is the monthly interest that remains due ...
  2. Limit Order

    A limit order is an order placed with a brokerage to execute ...
  3. Market Order

    An order that an investor makes through a broker or brokerage ...
  4. Pension Shortfall

    A pension shortfall occurs when a company with a defined benefit ...
  5. Bracketed Buy Order

    Bracketed buy order refers to a buy order that has a sell limit ...
  6. Immediate Or Cancel Order - IOC

    An immediate or cancel order (IOC) is an order to buy or sell ...
Related Articles
  1. Trading

    Why limit orders may cost more than market orders

    Learn the difference between a market order and a limit order, and why a trader placing a limit order sometimes pays higher fees than a trader placing a market order.
  2. Investing

    Understanding Market Orders And Limit Orders

    A market order executes a transaction as quickly as possible at the present price. Immediacy is the main concern. A limit order is executed at or below a purchase or sale price. Price is the ...
  3. Trading

    Understanding order execution

    Find out the various ways in which a broker can fill an order, which can affect costs.
  4. Trading

    Stop-Loss or Stop-Limit Order: Which Order to Use?

    While both can provide protection for traders, stop-loss orders guarantee execution, while stop-limit orders guarantee price.
  5. Trading

    Introduction To Order Types

    A trade order is an instruction that is sent to a broker to enter or exit a position. Learn about the various types available to investors.
  6. Investing

    Understanding Buy Stop Orders

    A buy stop order is an order to buy a stock at a specific price above its current market price.
RELATED FAQS
  1. How does a stop order and a stop limit order differ?

    Traders use stop orders and stop limit orders as stop losses and regular investors should understand how each type works. Read Answer >>
  2. What is the difference between a buy limit and a stop order?

    Learn the difference between buy limit orders and stop orders, including stop loss orders, and understand the risks of the ... Read Answer >>
  3. What is the difference between a buy limit and a sell stop order?

    Understand the differences between the two order types, a buy limit order and a sell stop order, and the purposes each one ... Read Answer >>
  4. What's the difference between a stop and a limit order?

    A limit order is an order that sets the maximum or minimum at which you are willing to buy or sell a particular stock. With ... Read Answer >>
  5. How do I place an order to buy or sell shares?

    Read a brief overview of how to open a brokerage account, how to buy and sell stock, and the different kinds of trade orders ... Read Answer >>
  6. When is a buy limit order executed?

    A buy limit order is only executed when the asking price is at or below the limit price specified in the order. Read Answer >>
Trading Center