Execution risk in trading

Execution risks in trading are a major concern for both retail traders and institutional investors.

These risks can significantly affect the profitability and efficiency of transactions and yet they constitute one of the least addressed factors in training.

Here we will discuss the main aspects of execution risks, including:

Best execution ? Obligation to execute orders on behalf of clients under the most favorable conditions possible. It takes into account price, speed and probability of execution.
Execution slippage - Difference between the decision price at the time a trade is ordered and the final execution price.
Trading restriction - Temporary trading restrictions or halts to prevent excessive volatility or market manipulation, which may impact trade execution.
Market Impact ? Change in the price of an asset caused by the execution of a trade. It generally leads to less favorable prices for large orders.
Market depth - Measurement of the market's ability to support large orders without significant impact on price. Indicates the liquidity of the asset.
Brokerage fees ? Total expenses incurred in executing a trade, including brokerage fees, taxes, and market impact cost. Affects the net result of the transaction.

Best execution
This is the obligation of brokers and market participants to ensure the most advantageous execution of orders for their clients, taking into account factors such as

the price
speed
the likelihood of execution and settlement
the size
the nature of the order

Best execution aims to maximize the value of a client's transactions.

If not achieved, transaction results may be suboptimal, which could result in higher costs and lower returns for clients.

Execution slippage
Execution lag, often called slippage, is the difference between the decision price (the price at which a trader decides to make a trade) and the final execution price.

This gap may be due to market movements between when the order is placed and when it is executed.

High volatility and low liquidity can exacerbate slippage, which can result in significant costs (particularly in the case of large transactions or fast-moving markets).

Limit orders and market orders

To avoid slippage problems, it is best to only use limit orders.

Market orders can be executed at any price.

Trading Restriction
Trading restrictions are mechanisms put in place by exchanges to prevent extreme volatility or market manipulation.

These may include measures such as circuit breakers that temporarily halt trading when prices reach predetermined thresholds.

Although these restrictions are intended to stabilize markets, they may also present execution risks by delaying or preventing the execution of transactions.

This can lead to unfavorable execution prices when trading resumes.

Market impact
Market impact refers to the effect of a large order on the price of a security.

Large orders, particularly in an illiquid market, can cause the price to vary significantly, up or down, depending on whether it is a buy or sell order.

This move can be detrimental to the trader because it can force the order to be executed at less favorable prices, which can reduce the overall efficiency of the trade.

Market Depth
Market depth is a measure of the market's ability to support relatively large orders without impacting the price of the security.

It is closely linked to liquidity.

A market with good depth can process large orders without significant price changes, thereby reducing market impact.

In contrast, a shallow market can experience large price fluctuations even with relatively small orders.

This may increase the risk of adverse price movements during trade execution.

Brokerage fees
These are the costs associated with executing trades.

They include brokerage fees, commissions, bid-ask spreads and any other expenses incurred during the transaction.

High brokerage fees can erode trading profitability, particularly in strategies involving frequent trading or in markets where spreads are lower.