Frank Birch Veteran   Posts: 171 Joined: 3/25/2006 Location: UK  User Profile | Over the past month, i have had a few emails concerning building strategies for trading USA based stocks end of day and what to look for in the actual set up of the profile for testing. The one thing that stood out to me that not a lot of traders do not add any form of figure to the slippage side of the build in testing? In Futures we allow $7.50 round trip ($2.50, slippage/ $2.50, Entry/ $2.50, Exit). For Forex similar but a higher figure. So i have written a document on my thoughts to consider when building and testing mechanical trading strategies for stocks, hope it helps. Introduction to Slippage In the realm of stock trading, several factors can influence the outcome of your trades, and one of the most critical yet often overlooked is slippage. Slippage occurs when there is a difference between the expected price of a trade and the price at which the trade is actually executed. This document aims to shed light on the concept of slippage, its potential impact on trading strategies, and how it interacts with other trading costs such as entry and exit commissions. Slippage Explained Slippage is not a fixed cost but varies based on market conditions, the liquidity of the stock, and the size and type of order placed. It can either work against you, resulting in a higher purchase price or a lower sale price than expected, or in your favor, offering a better execution price than anticipated. Factors Influencing Slippage Stock Liquidity: Stocks that are traded in high volumes typically experience lower slippage due to the availability of more buyers and sellers. In contrast, less liquid stocks may have a higher bid-ask spread, leading to greater slippage. Market Volatility: High market volatility can lead to rapid price changes, increasing the likelihood of slippage. Order Size: Larger orders may not be filled at a single price point if they exceed the available volume at the best bid or ask, leading to higher slippage. Type of Order: Market orders are most susceptible to slippage, as they are filled at the best available price, which may not be the expected price. Limit orders can mitigate slippage by specifying the maximum or minimum price at which you are willing to buy or sell. The Cost of Slippage For highly liquid stocks in stable market conditions, slippage might be minimal, ranging from $0.01 to $0.10 per share. However, in more volatile markets or for less liquid stocks, slippage can significantly increase, ranging from $0.10 to several dollars per share. Using a conservative estimate of $0.25 per share for slippage can cover most scenarios under normal conditions, yet traders should be prepared for higher slippage in less favorable conditions. Entry and Exit Commissions In addition to slippage, traders must consider the impact of entry and exit commissions on their trading costs. While many U.S. brokerages have moved to a zero-commission model for standard online trades, certain transactions may still incur fees ranging from $5 to $10 per trade. These fees, combined with slippage, can substantially affect the profitability of trades. Managing Slippage and Trading Costs Understanding and managing slippage is crucial for minimizing trading costs and maximizing profitability. Traders can employ several strategies to mitigate slippage, including: Trading during peak liquidity times to benefit from lower bid-ask spreads. Using limit orders to control the maximum price paid or the minimum price received for a stock. Being mindful of market news and events that can increase volatility and, consequently, slippage. Adding a conservative figure (0.25) in Test settings, profit calculation. Conclusion Slippage is an integral aspect of stock trading that can significantly impact trade outcomes. By comprehensively understanding slippage and its contributing factors, traders can better manage their trading strategies and costs. Coupled with an awareness of entry and exit commissions and the judicious use of leverage, traders can navigate the complexities of the stock market more effectively, aiming for optimal trade execution and profitability. Regards Frank Birch [Edited by Frank Birch on 2/25/2024 6:03 AM]  Attached file : Slippage.png (110KB - 165 downloads) |
