Implementation Shortfall

Implementation shortfall is the difference between the result you would have had if you could trade instantly, at no cost, at the price when you decided to trade, and the result you actually got. It was introduced by André Perold in a 1988 paper and is the most complete single measure of trading cost, because it captures everything: commissions, the spread, delay, market impact and the cost of trades that never filled.

The idea: a paper portfolio vs reality#

Imagine two versions of the same decision:

• Paper portfolio: the moment you decide to buy, you own the full position at that instant's price, with no costs.
• Real portfolio: you send orders, wait, pay costs, move the price a little and maybe fill only part of the order.

The gap between their results is the implementation shortfall.

The formula#

For a buy order:

Shortfall = (Average fill price − Decision price) × Shares filled
          + (Final price − Decision price) × Shares not filled
          + Explicit costs

The first line is the execution cost on what you bought. The second is the opportunity cost of what you did not buy, valued at where the price ended up. The third is commissions and fees. Divide by the paper portfolio's value to express it in basis points.

Breaking down the shortfall#

Professionals split the shortfall into parts so they can see which to work on:

Notice the tension: trading slowly reduces impact but increases timing and opportunity costs. Trading fast does the reverse. Choosing the balance is the problem Optimal Execution and the Almgren-Chriss Model models try to solve.

Why it is better than slippage alone#

Slippage measured only on filled shares ignores missed trades. A trader who uses very passive limit orders can show excellent slippage numbers while missing many of their best trades. Implementation shortfall counts those misses as a cost, which reflects what actually happened to the portfolio. See Slippage Analysis and Opportunity Cost.

Using it as an individual trader#

You can apply a simple version in your journal:

1. Record the price when you decided to trade.
2. Record your fill or fills.
3. If you did not fill, record where the price was at the end of your planned holding period.
4. Compare totals over time.

This shows whether your execution habits, such as waiting for a slightly better price, are helping or hurting overall.

Frequently asked questions#

What is implementation shortfall?#

The difference between the return of an ideal paper trade at the decision price and the return actually achieved, including all costs and missed fills.

Who uses implementation shortfall?#

Asset managers, brokers and traders who need to measure execution quality, especially for large orders.

How is it different from VWAP as a benchmark?#

VWAP compares fills with the average price during trading and ignores delay and missed shares. Implementation shortfall measures against the decision price and includes them.

Sources#

• Wikipedia, Implementation shortfall