Execution Algorithms vs Alpha Algorithms

When a pension fund wants to buy $200 million of a stock, it cannot simply send one market order: the purchase would push the price up sharply and reveal its intentions. Execution algorithms solve this by breaking large orders into many smaller orders, timed and placed to balance speed against market impact. They are the most widely used form of algorithmic trading, offered by brokers and banks to institutional clients. The core benchmarks are covered in VWAP, TWAP and POV Execution; this lesson gives the broader picture.

The execution problem#

Every large order faces a trade off:

Execution algorithms choose a path between these extremes. See Market Impact and Optimal Execution and the Almgren-Chriss Model.

Common execution algorithms#

A worked example#

Measuring execution quality#

Transaction cost analysis (TCA) reports these measures to help firms choose brokers and algorithms and meet best execution obligations. See Best Execution and Execution Quality and Slippage Analysis.

Smart order routing#

Modern markets have many venues: exchanges, dark pools and other trading systems. Smart order routers decide where to send each child order, based on prices, fees, rebates, fill probabilities and hidden liquidity. See Order Routing and Smart Order Routing.

Information leakage#

Predictable patterns, such as buying exactly the same amount every minute, can be detected by other traders, who may trade ahead and raise costs. Good algorithms randomise order sizes and timing and use a mix of order types. See Front-Running.

Execution algorithms for individuals#

Retail traders rarely need complex algorithms, but the principles still apply: for larger orders in less liquid assets, splitting orders and using limit orders reduces costs. Some brokers offer VWAP and TWAP order types to individual clients. See Limit Orders.

Frequently asked questions#

What is an execution algorithm?#

A program that breaks a large order into smaller pieces and schedules them to reduce market impact and trading costs.

What is the difference between VWAP and TWAP algorithms?#

VWAP trades in proportion to expected volume through the day; TWAP spreads trades evenly over time.

What is implementation shortfall?#

The total cost of executing an order compared with the price when the decision to trade was made, including market impact, delays and missed fills.

Next, learn about the fastest traders in High-Frequency Trading.