What Is Slippage in Trading – The Hidden Cost Unveiled

ByOddmund Groette Platforms, brokers, legislation, commission, and slippage

What is slippage in trading? Slippage is a hidden cost that is difficult to quantify. It’s the difference between a theoretical price and the price you get in real and live trading.

What is slippage in trading?

Slippage is the difference between fictional results when testing strategies, and the actual results in real life adjusting for commissions and transaction costs. It’s a “hidden” cost.

Commissions are a cost we know. However, costs related to buying and selling are not always easy to measure. When you backtest a strategy, the entry and close are estimated on an executed price.

But in real life, you never get those prices. If your test shows an entry on 100, in live trading this strategy might buy those shares at 100.02 – not 100. That means your strategy will be less profitable than when testing. This is slippage!

For example, Apple might have a bid of 172.02 and an offer at 172.09. If you want to go long, what price will you bid at? Will you hit the offer price and buy at the market or will you bid at 172.05?

If you bid 172.05 you might get a better price, but you also risk not buying at all unless someone hits your bid. This is slippage. It’s a hidden cost that a backtest can’t capture.

My experience tells me that the backtest results are always much better than real trading. As a rule of thumb, I anticipate that my backtests will result in 50% lower profits in live trading. Not only because of slippage but also because of the ever-changing market cycles. Testing strategies always curve fits more than you think.

Slippage in trading is normally worse than most traders realize, but it depends on the instruments you are trading. We have earlier provided some real facts from slippage in live trading.

To be on the safe side, when you do backtesting, always be prepared and assume that slippage goes against you.

FAQ:

– Why is slippage considered a hidden cost?

Slippage is often regarded as a hidden cost because it’s not as easily quantifiable as explicit costs like commissions. It represents the divergence between the expected execution price from testing and the real-world execution price in live trading.

– What causes slippage in trading?

Slippage can occur due to various factors, including differences in bid and ask prices, market volatility, order size, and the timing of order execution. When placing an order, the execution price might not be exactly as expected due to these factors.

– Is slippage consistent across all trading instruments?

Slippage in trading can vary depending on the specific instruments being traded. Different markets and assets may experience varying levels of slippage. It’s important to consider the potential impact of slippage when trading different instruments.

I’ve got an Msc from Heriot-Watt University, Edinburgh (1996), in addition a to a business administration degree the Norwegian School of Management (BI – 1994). Did my mandatory military service in between.

After university, I worked two years as an auditor (1996-1998).

I co-founded Aksjeforum.com in 1998/99 - one of the first websites about trading and investing in Norway. It was later acquired by Digi.no in 2001.

I have written 4 books about trading (in Norwegian). One of them has sold 30,000 copies, a record for a financial book in Norway.

From 2001 until 2018 full-time independent prop trader (Series 7 in 2001) and investor.

2018-today: Investor, writer, analyst.

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