Hedge Fund Trading & Execution
In hedge funds, you do not get paid for being 'right in theory.' You get paid for getting into the position at a price that preserves your edge, staying in it without technical blow-ups, and getting out when the tape turns.
Note
Module Reading: This article accompanies the Trading & Execution module in our Hedge Fund interview prep track.
In hedge funds, you do not get paid for being "right in theory." You get paid for getting into the position at a price that preserves your edge, staying in it without technical blow-ups, and getting out when the tape turns. That is why trading and execution show up constantly in interviews: great theses die from sloppy fills, hidden liquidity, earnings gaps, forced buy-ins, and crowded shorts.
This module is about connecting your investment view to an executable plan. You will learn how to think in order types, liquidity, urgency, benchmarks (VWAP, TWAP, arrival price), and short mechanics like borrow, recalls, and squeezes.
Interview Shortcut: Always Speak in Trade-offs
Execution is almost always a three-way trade-off: (1) market impact (moving the price against yourself), (2) opportunity cost (waiting and missing the move), and (3) information leakage (advertising your intent). If you frame answers around these trade-offs, you will instantly sound more senior.
1) From Thesis to Order Ticket
A trade starts at the moment you decide to take risk, not when you click "send." The decision price (or arrival price) becomes your psychological anchor, and everything after that is implementation risk: you might get partial fills, pay up in a thin book, or move the market as others detect your footprint.
Interviewers like to see that you separate alpha from implementation. Your thesis might say "this is 25% upside," but your realized edge is "25% minus spreads, impact, borrow, and timing mistakes."
A practical way to structure any execution answer is:
- Define urgency (do you need it on now, or can you work it?)
- Map liquidity (how deep is the book, how stable is volume, what events are ahead?)
- Choose a tool (order type, algo, venue)
- Define failure modes (what makes you stop, re-price, or walk away?)
Want to practice execution-style interview questions (order types, benchmarks, short mechanics) with instant feedback?
2) Liquidity and Market Impact
Liquidity is not just "average daily volume." What matters is the liquidity availableat your moment of need, under the conditions you are trading. A calm mid-day tape behaves very differently from the open, the close, an index rebalance, or an earnings gap.
You can think of liquidity in three layers:
Liquidity Dimensions
| Term | Definition |
|---|---|
| Tightness | How expensive is it to trade right now? (spread, fees, immediate price concession) |
| Depth | How much can you trade without moving price? (book size, hidden liquidity) |
| Resilience | How fast does price recover after trades hit the book? (impact decay) |
Pre-Trade Checklist
| Term | Definition |
|---|---|
| Wide spreads vs history | Fragile liquidity—market orders get punished |
| Low displayed depth | Thin book—impact spikes, partial fills |
| Spiky volume profile | Event-driven—timing matters more than patience |
| High short interest / crowded positioning | Squeeze risk—exits can become one-way markets |
| High borrow cost / hard-to-borrow | Scarcity—shorts can become forced buys |
Common Interview Trap
If you say "I'd just use a limit order," be ready for: "What if it never fills and the catalyst hits?" Always explain how you balance price discipline withgetting the risk on.
You want to buy 3% of a stock's ADV ahead of a known catalyst tomorrow morning. The spread is wider than usual and the book is thin. Which execution plan is most defensible?
3) Order Types and Venues
Most hedge fund interview execution questions are not about exotic order types. They are about whether you understand the purpose of a few core tools and when each one is dangerous. The simplest useful mental model is: aggressive orders buy certainty, passive orders buy price.
Core Order Types
| Term | Definition | Note |
|---|---|---|
| Market Order | Maximum urgency, minimum price control | Useful only when cost of not being in is clearly higher than execution costs |
| Limit Order | Price control, uncertain fill | Great when you can be patient or when the tape is noisy |
| Marketable Limit | Behaves like market up to a cap | Often the 'grown-up' answer—controls worst-case outcomes |
| IOC / FOK | Control over partial fills (IOC allows partial, FOK does not) | When avoiding signaling or only wanting size at a specific level |
| Stop / Stop-Limit | More about risk management than entry | Don't place obvious stop levels in crowded names |
Venue choice matters because it changes who you trade against and how much you reveal. On lit venues, you access displayed liquidity but also show your intent. In dark pools or midpoint venues, you may reduce signaling and spread cost, but you accept uncertainty and potential adverse selection.
Clean Interview Answer Template
"I'd avoid a pure market order because liquidity is thin. I'd start with a marketable limit around the offer with tight bounds, work it with a participation cap, and opportunistically use midpoint/dark liquidity to reduce spread cost. If volume picks up (or the price starts to run away), I'd step up urgency to control opportunity cost."
4) Execution Algos and Benchmarks
Once size is meaningful relative to liquidity, execution becomes a scheduling problem: you are slicing risk over time to balance impact and timing. The common benchmarks are not just jargon, they are interview shorthand for what you optimize.
The Four Benchmarks You Should Know Cold
| Term | Definition | Note |
|---|---|---|
| TWAP | Time-weighted average price: equal slices over time | Simple, predictable, can be gamed in some tapes |
| VWAP | Volume-weighted average price: trades in line with market volume curve | Good when volume is stable and you want to blend in |
| POV | Percentage of volume: you are X% of the tape | Great for liquidity sensitivity; risky if volume collapses |
| Arrival Price / Implementation Shortfall | Optimizes versus the decision price | Explicitly balances speed vs impact |
A simple implementation shortfall framing (interview-friendly) includes:
- Explicit costs: commissions, fees, taxes
- Implicit costs: spread and market impact
- Opportunity cost: the move in the price on the unfilled portion
You decide to buy a stock at €100. You end up buying half at €101 and half at €103. Ignoring commissions, what is your implementation shortfall (per share) versus decision price?
5) Execution Quality and Real-World Constraints
Strong hedge funds measure trading like they measure investing: with attribution. Post-trade, you want to know whether slippage came from spreads, your own impact, or adverse selection. Even a simple decomposition sounds great in interviews: "arrival vs execution VWAP, plus spread, plus fees, plus opportunity cost."
Modern trading is also constrained by operational plumbing. Settlement speed matters because it compresses the timeline for fails, recalls, and operational breaks. The U.S. moved to T+1settlement in 2024, which impacts how aggressively you can run crowded shorts and how quickly problems surface when things go wrong.
6) Short Mechanics: Borrow, Fees, Recalls, and Squeezes
Shorting is where execution meets structural risk. Your thesis can be perfect and you can still lose money if you cannot maintain borrow, if borrow costs explode, or if you get forced to cover into a squeeze.
At a high level, a short has three moving parts:
- Locate and borrow availability: can your broker actually source shares to deliver?
- Borrow economics: what is the borrow rate, and does it kill your expected return?
- Recall / buy-in / squeeze risk: can you be forced out at the worst time?
Short Mechanics You Should Explain
| Term | Definition |
|---|---|
| Locate Requirement | Brokers need reasonable basis that shares can be borrowed before executing a short |
| Hard-to-Borrow Names | Borrow can be scarce, expensive ('specials'), and subject to recall |
| Dividends and Corporate Actions | Shorts owe dividends (payment-in-lieu); corporate actions can tighten borrow |
| Fails-to-Deliver Dynamics | Persistent fails can trigger close-out mechanics and forced buying pressure |
| Crowding and Squeezes | When borrow is tight and positioning crowded, price can become discontinuous |
What Interviewers Love to Hear
"I size shorts with borrow and squeeze risk in mind. If borrow is unstable, I either reduce size, hedge with options, or demand a higher expected return to compensate for forced-cover risk."
You are short a hard-to-borrow stock. Borrow cost spikes, your prime broker signals potential recall risk, and the stock starts to squeeze on heavy tape. What is the most professional immediate response?
Key Takeaways
What You Should Remember
- Execution is a trade-off between impact, opportunity cost, and information leakage. Say this early in interviews.
- Liquidity is regime-dependent: spreads, depth, and resilience change at open/close, around catalysts, and in crowded names.
- "Adult" order answers usually involve marketable limits with bounds, not pure market vs pure limit.
- Know the benchmark language: TWAP/VWAP/POV are pacing tools; arrival price / implementation shortfall is about protecting edge versus decision.
- Talk about TCA simply: arrival vs execution, plus spread, fees, and impact, plus opportunity cost.
- Shorts are about plumbing: locate, borrow cost, recall risk, and squeeze dynamics can dominate fundamentals.
- Always define failure modes: what makes you pause, re-price, hedge, or exit.
Continue Your Hedge Fund Interview Prep
Master these related topics to complete your hedge fund interview preparation:
- Hedge Fund Fundamentals & Strategy Types — L/S equity, event-driven, macro, and quant strategies
- Hedge Fund Market Analysis & Investment Ideas — Generate and defend trade ideas
- Hedge Fund Valuation & Price Targets — Turn analysis into tradable price targets
- Hedge Fund Portfolio Construction — Gross/net exposure, position sizing, and risk management
- Hedge Fund Stock Pitch Mini Cases — Practice long and short pitch frameworks
- Hedge Fund Macro Scenarios & Market Judgment — Economic scenarios and articulating conviction
- How the 3 Financial Statements Link Together
- Comps vs Precedent Transactions