What Is Slippage?
One word I often use in my articles is the word slippage. Simply explained this means the difference between fictional results when testing strategies, and the actual results in real life adjusting for commissions and transaction costs.
Commission is a cost we know. However, costs related to buying and selling is not always easy to measure. When testing a strategy the entry and close is estimated on an executed price. In real life you never get those prices. If your test shows an entry on 100, trading this strategy live you might buy those shares on 100.02 instead. That means your strategy will be less profitable than when testing.
My experience tells me that the test results will always be much better than real trading. I calculate that my test results will be halved when trading it live. Not only because of slippage, but also because of the ever changing market cycles. Testing strategies always curve fits more than you think.
Doesn’t your backtester let you specify slippage explicitly?
What do you mean? Slippage is very difficult to measure unless providing liquidity. Most of the strategies i test is usually on the open or on the close, and thus slippage should be minimal.
I mean, that backtester should cut some points toward loss on every trade. Yes it’s difficult to measure, but even if you use approximate value in backtesting – I think you should get more accurate result anyway.
Hi Mikhail. I take your point but I disagree. As mentioned above, almost all my strategies is based on the opening, on the close or a limit orders. All those should have close to zero slippage unless we move the market. If I test a breakout strategy, that would be another story.
Truly wonderful content – Thanks so much for sharing. Hope you’ll have a great 2013!
I am a beginner running a 200K USD daily algo for a long/short pair trade. My backtesting results are great, but I just learned about slippage and would like to factor that into my backtesting somehow.
I am trading the DowJ stocks – from your experience, what would be the right number to shave off each transaction due to slippage?
Thanks!
Hi, thanks for your nice words. 2013 have started nicely, thanks 🙂 For stocks I’m happy if I can get around 40-50% of the profits for stocks in real trading. For liquid things like Dow Jones slippage is a lot less.
Thank you!