Order Execution
Knowledge Hub

Bid-Offer Spread Bid-offer spread measures the difference between the buy and sell prices. The larger the difference between the prices the more the market will have to move to make a particular position profitable. When the spread is zero, this is referred to as a “choice price“. This is the simplest metric to compare between brokers (and LPs). The bid/offer spread essentially represents liquidity. Liquidity is the degree to which an asset can be quickly bought or sold on a marketplace at stable prices. A narrower spread implies a deeper market where there is a sufficient volume of open orders so buyers and sellers can execute a trade without causing a big change in the price. That’s in contrast to a weak or “thin” liquidity environment, where large orders tend to move the price, increasing the cost of executing trades, and deterring traders, in turn, causing a further decline in liquidity. An important driver of liquidity is the rate of change in prices. In times of extreme price volatility, spreads tend to widen and brokers’ ability to execute large orders is reduced.

Fill Ratio Fill ratio measures the number of successfully filled orders as a fraction of the total number of orders placed, normally stated as a percentage. What good is a tight spread if you don’t get filled? Rejected or unfilled orders represent an opportunity cost. The trader must forego the opportunity to trade or attempt to trade again at a potentially worse price. This means that higher fill ratios are desirable. The higher the fill ratio, the better, as a reject will normally result either in a missed opportunity to trade or at a worse price if the order is later resubmitted to the same (or different) venue. For a quoted price stream from a single LP, the fill ratio should just be a measure of whether the deal was done at the agreed price or not. Basically, was the order filled or rejected (or requoted)? Rejects (errors aside) are due to insufficient liquidity to match the trader’s order.

Hold Time Hold time is a discretionary delay between order reception and execution. Hold time measures the discretionary element of execution latency, which is the time observed by the trader between placing an order and receiving notification of the fill or rejection. Execution latency is the time taken between an order being transmitted from the trader’s system and the receipt of a response. “Hold time” is the commonly used name for discretionary latency where the execution of an inbound order from a trader is deliberately delayed pending a decision to fill or reject by the liquidity provider’s systems. This period of time is also referred to as the last look window. Discretionary latency is any time added where the order is held prior to executing a trade. Liquidity providers (LPs) may apply or vary hold time based on their assessment of a customer’s market impact, the current market conditions, or their own appetite to trade in a given direction. Higher hold times and execution latencies not only exacerbate the opportunity cost associated with rejects but also represent an opportunity cost on filled orders because, while the trader is waiting for a response, they are committed to honoring the potential trade and may be unable to execute the remainder of their strategy.

Market Impact Market impact is the market reaction to a given set of trades. Market impact characterizes the response of the market, typically in terms of price changes, to a given set of trades. The interpretation of market impact is highly subjective. One trader’s strategy may rely on minimizing impact while another’s may actively benefit from a pronounced and consistent post-trade reaction, but also suffer if that reaction occurs before a set of related trades is completed.

Price Variation Price variation is a trader’s view of the difference between a desired or expected price and the actual execution price achieved by an order. Price variation measures the difference between the price the trader expected and the price at which they were filled, arising from movements in the underlying market prices. It is often separately referred to as “slippage” or “price improvement” for adverse and favorable outcomes respectively. While attention is often focused on slippage (execution at a worse than expected price) when using market orders, we should expect to experience both slippage and improvement. Traders using limit orders may have been conditioned to expect neither. They assume that limit orders cannot slip and many traders do not even consider measuring price improvement. Price variation can be either: Symmetrical: both price slippage or price improvement are passed to the customer without restriction. Asymmetrical: the price improvement is passed to the customer is limited but price slippage isn’t. Ideally, symmetrical price variation should be demonstrated in both market and limit orders. LPs may choose to fill every order at its limit price, even though fills on market orders indicates that a better price should be available for some proportion of the time. This means that even limit orders should also experience price improvement. Measurement of slippage or improvement requires information that may only be available in the trader’s own logs. We can not rely on orders to carry the price which prompted the decision to trade – market orders do not carry a price at all and the price on a limit order is not necessarily the same value as the decision price. This makes this metric potentially both opaque and highly subjective.

Riskless Principal A broker acts as a riskless principal if, acting at its customers’ request, it purchases an asset from the market for its own account (as principal), records that transaction in its own trading books, and more or less immediately, sells the same asset to the customer (also as principal), either at the same price (with a “commission”) or at a markup (with no commission). This means that are two transactions;
  • One between the customer and the riskless principal (the broker)
  • One between the riskless principal (broker) and market (external counterparty or “liquidity provider”).
A riskless principal is compensated in one of two ways:
  • A markup between what it paid for the asset “in the market” versus what it sold it for to the customer.
  • A separate payment from the customer to the riskless principal, which sounds like a commission but is technically not a commission and should be called a “fee“.