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Measuring Slippage: Make it a Top Priority!
July 24, 2006
The computer reported a gain of +$750 before commissions and fees for the Compass system's day trade today, but clients trading the system earned $775 on the trade. What happened? Where did that extra $25 come from? It's called slippage, and it is the difference between where the computer signaled the entry and exit for a trade and where actual clients, with actual money, entered and exited the market using the computer's signals. Now today was a bit of an anomaly, as slippage is usually a negative number, but we need to be able to tout our great execution now and then.
But shouldn't the computer reported profit and the profit in actual client accounts be one and the same, you ask? That would be nice, but no, there will always be a difference between the prices where the computer generates the signals and the prices actual clients using actual money get.
This can seem like an alarming problem at first, as even small differences of $20 to $30 per trade can add up to investor's actual results being $1000 — $2000 less than the computer has generated over the course of a year.
The good news is slippage can be fully accounted for in backtesting, and fully measured in real-time. All of the hypothetical testing and reports Attain produces include an allowance for slippage in order to give investors as realistic a picture as possible for what sort of performance they can expect moving forward.
Getting a handle on how much slippage to expect in each market a trading system includes in its portfolios is paramount to achieving success with these systems. If too little slippage was used in the testing, a system may be operating exactly as it was designed to operate, but at the same time grossly under performing an investor's expectations.
Too many developers take the easy way out, unfortunately; by assigning a single number for slippage to each market. This number generally includes commission costs as well, and ranges from $75 per trade to $100 per trade. Assuming a round turn fee of $40 including all fees, the leading developers are allotting just $30 per buy and $30 per sell for slippage.
Is this enough? Are these slippage estimates realistic? The answers to these questions depend on many factors, but in first understanding why slippage exists, we can start to make educated decisions on how much slippage to account for in our backtesting.
Why does a difference exist between the computer's fills and actual fills?
Because trading systems are reactive - working off of the last tick in the data. The last tick reported by the exchange is not necessarily the next tick an investor trading the system will receive, however; given investors must buy the offer and sell the bid. As a refresher, traders wishing to buy submit bids, or what they're willing to pay, and traders wishing to sell submit offers for what price they are willing to sell at. A trade is done when a trader's bid matches another trader's offer, enabling them to buy and sell to each other at the agreed upon price. This agreed upon price is the "last price" reported by the exchange and the price a trading system uses to generate its buy and sell signals. Of course, the whole process happens near the speed of light at times in the real world, with traders frantically moving, canceling, and initiating bids and offers nearly every second.
So slippage is a function of the spread between the bid and ask price of the market you are utilizing. For example, the average spread between the bid (the highest price someone is willing to buy at) and offer (the lowest price someone is willing to sell at) in the S&P 500 futures market is around 5 ticks or 1/2 a full point. Slippage on a market or stop order in the full size S&P, therefore, can be estimated to be 1/2 a full point, or 5 ticks, or $125. .
You often hear about liquidity being the main factor in determining how much slippage investor's can expect in a certain market, and this is true. Liquidity is just another way of looking at the spread between the bid and offer prices. The spread between the bid and offer defines a market’s liquidity – with a smaller spread equaling more liquidity. For example, a liquid market like the Eurodollar futures has a bid/ask spread of just 1 tick, or $25; while an illiquid market like Lumber futures could see a bid/ask spread of 2 full points, or $220. It logically follows then that there is less slippage in more liquid markets.
It's not only the wide bid/ask spread in illiquid market that is troublesome. Another issue in illiquid markets can be trading system orders moving the market. This is obviously not ideal, as the trading system starts causing price moves instead of reacting to them. If the system caused the price move, and not some underlying event or stimulus, the odds of prices continuing in that direction once the system is done pushing prices that way is remote at best.
This scenario plays out quite frequently in in less liquid markets like Lumber, Palladium, and Propane. Even a single trading system coming into any of these markets with an order of 10 to 20 contracts can send prices on wild moves as an order imbalance causes prices to shift and open at the much higher or lower prices. The result of this can be an increase in the actual risk per trade while the system tells you the risk is much less (as its basing the risk off the prior day's closing price). While an investor won't technically see slippage on these "gap opens", as the system will show it entered at the next day's opening price and that will be the price investors get, there is a "hidden slippage" in these scenarios due to the "shifted" prices and often dramatically increased risk.
There is still slippage in trend following systems even if there is not a "price shift" due to the system orders. In these cases, the volume of each market and how big or small the opening range of prices is in these markets can have a direct impact on the amount of slippage to be expected. As defined by the CBOT (Chicago Board of Trade) the opening range is "A range of prices at which buy and sell transactions took place during the opening of the market."
Depending on market volume the opening range is typically equal to the trades that take place during the first minute of trading at both the bid and offer prices. US exchanges generally define the opening range as the first three minutes of trading, but most brokers should be able to fill your order well before the three minute mark.
With the opening range in many markets equal to several points and often hundreds if not thousands of dollars, not just a single tick as a $30 slippage allotment would imply - Attain Capital set out to research just how much slippage can be expected in each market. Our estimates are shown in the table below:
Attain slippage estimates:
Our estimates showed an average slippage of just over $135 per round turn. This is almost twice as much as most developers are allotting for slippage, but before sounding the alarm, however; realize that this number includes slippage for several foreign markets and stock indices which many long term systems avoid. But the estimates do show a wide range of slippage amounts between those markets that are included in long term systems, leading to Attain belief that hypothetical testing of multi-market systems should be done with unique slippage numbers per each market.
The following table below was compiled by Attain Capital to assist investors in assigning realistic slippage numbers to their backtested system results. These figures are estimates of the average slippage one could expect when trading each of these markets through Attain Capital. We must stress that actual slippage can and will vary, and would most likely be higher if trading pit markets through an electronicplatform or through another firm not utilizing independent floor brokers. The 'Volume Concerns' column shows a 'Y' value if we believe normal trading system volume (10-50 contracts) would move the market substantially away form its fair value.
- Walter Gallwas
IMPORTANT RISK DISCLOSURE
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US stocks continue to move lower last week due to weak earnings in the tech sector and small caps. SP 500 futures were very choppy as weakness in the NASDAQ and tensions in the Middle East held stocks back despite b earnings from a host of blue chip companies. For the week SP futures gained +2.50 points closing at 1244.70. Unfortunately NASDAQ futures were unable to keep pace as the tech laden index fell -1.00%. Smallcaps also were weak with Russell 2000 futures dropping -1.26% and SP Midcap 400 futures falling -2.04%.
Energy prices finally took a breather last week as the initial panic caused by the fighting in the Middle East subsided last week. While tensions are still high and the fighting continues many traders conceded that the most recent round of buying was overdone and the markets had nowhere to go but down in the near term. For the week Crude Oil futures fell -5.44%, Unleaded Gas futures moved -5.18% lower, Heating Oil futures were down -6.08%, and Natural Gas futures lost -4.35%.
Metals also pulled back as the initial flurry to the precious metal safe haven came to an end. High Grade Copper futures led the downward move falling -10.49%, Godl was next after dropping -7.16%, Palladium was down -6.749%, Silver fell -5.94%, and Platinum lost -3.71% for the week.
Two markets the have been relatively throughout the Middle East crisis are US Bonds and foreign currencies. Despite an initial rally in the bond markets both sectors have been very choppy. Last week foreign currencies including Eurocurrency, the Swiss Franc, Japanese Yen, and British Pound moved slightly higher against the US Dollar. US treasury futures also moved slightly higher as bond yields were down slightly last week.
The agricultural markets picked up some of the slack as markets like Soybeans (-4.24%), Corn (-8.40%) and Wheat (+2.45%) all saw big moves last week. Tropicals were also active with Cotton gaining +6.33% while Coffee (-2.70%) and Sugar futures (-3.82%) both moved lower. Finally, the meats were mixed with Live Hogs falling -1.82% and Live Cattle gaining +0.57%.
Stock index futures finished the week around the unchanged mark but had some large daily ranges mid-week. Wednesday’s broad-based rally sparked profits for systems both domestically and abroad.
Top honors for last week goes to new system - Keystone SP which made +$3,712.50 on four trades - all of which were profitable. The highlight trade for the system came on Wednesday when the system went long ahead of the pack and pocketed +$2,725. Keystone is the new system by Founder Trading Systems.
RC Success eRL had a nice run as well last week with profits of +$1,256 per contract as it continues to have a solid year despite a tough July, while R-Mesa eRL has been on a hot streak recently and added +$1,137.50 in profits last week.
The long only system which waits for oversold conditions got just waht the doctor ordered last week, and Bounce eMD MOC had another profitable trade last week adding +$786 to the bottom line on one trade from Wednesday. Elsewhere in US markets, Compass eRL had two trades for a small loss of -$60.50, Impetus lost -$430 per contract on four trades, and Tanker CL had two trades for a loss of -$600. Compass SP had three trades for a loss of -$789.27.
Systems trading the Dax had moderate success last week, but underperformed compared to their U.S. counterparts as two bad days unfortunately sandwiched aroudn a great day last Wednesday. BetaCon 4/1 Dax had three trades last week that made $+797.84 after giving back some profits on Friday. Theta V1 Dax had two trades that added up to a similar figure of +$759.23 in profits. Beta V2 Dax had five trades for the week that resulted in a gain of +$732.66. The system took two trades on Wednesday and three on Friday and will often trade multiple contracts in a given trading session. BetaCon 4/1 ESX had three trades for profits of +$536.07. Beta V1 Dax had two trades for profits of +$520.05. Omega3 V1 Dax had the only other profitable foreign trade for a gain of +$238.58.
On the losing side for the foreign systems, Rayo Plus Dax lost -$548.51 on four trades. Epsilon Bund had four trades that lost -$554 after some choppiness in the treasury markets. Phi Plus had six trades for a loss of -$770.25.
Last week was an exciting week for swing systems, but none more than the FX strategies which claimed 3 out of the top 10 most profitable systems for the week. SC Forex GBPUSD registered the largest gain of the week earning +$3,000 on one trade that entered short with 2 units and quickly took profits. Other profitable FX figures included Delphi EURUSD +$1,900, and Delphi GBPUSD +$1,160 which both enjoyed a brief rally in the USD.
Beyond the FX markets, several index strategies performed well during last weeks down move. Tzar eMD entered short near the high of the week and was earning +$2,870 heading into the weekend. Other open / closed trade gains for the week included Delphi eMD +$1,882, Targets eRL +$1,290, Targets eRL+$1,290, Seasonal ST eRL +$1,250, Targets eMD +$1,196.67, Ping Systems +$759.40, Tzar NQ +$638.53, Axiom NQ +$615, Delphi eRL +$136, Tzar ES +$125, and Seasonal ST ES +$50.
Losing systems for the week included Bounce eMD Swing -$60, Gettess ES -$167.5, Axiom Index eRL -$690, Axiom eMD -$717.80, Tzar eRL -$860, Spartan ES -$900, and Jaws Narrowneck Bonds -$1,387.50.
As a preview - Today’s big market reversal was b enough to lock in profits for some swing systems and also initiate a few new long trades…
Long term trend following systems have be relatively quiet lately as choppy markets and high risk trades have limited trading opportunities. A quick glance at the open positions of the most popular trading systems tells us that the markets have been stuck in rut and that trends are few and far between. Systems like Aberration and Andromeda with 4 open trades, and Trend Simplicity with only 2 open trades, tells us exactly how though the market conditions are right now.
One popular trade for trend followers right now is holding short in foreign bond markets like the Eurobund, Swiss 10 year, Aussie 10 year, and Japanese Government Bonds. Despite a recent rally these markets have been trending lower for some time now with the threat of higher global interest rates (and Japan ending their decade long run at 0% interest rates), and have presented a decent trading opportunity for long term systems.
One system that has taken full advantage of the downward trend is Axiom LT which is short in the Eurobund for open trade profits of +2830 EUR, short in the Swiss 10 year for open trade profits of +4210 EUR, and short in the Simex JGB for an open trade loss of -$1330.
Other systems with open positions in the foreign bond markets include Aberration which is short in the Aussie 10 year for open trade profits of 1000 AUD and Brix which is losing -720 EUR on short Eurobund trade. Andromeda was stopped out of a short Eurobund trade last night for a loss of -1620.00 EUR per contract.
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IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading losses are material points which can adversely affect investor returns.
Past performance is not necessarily indicative of future results. The performance data for the various Commodity Trading Advisor ("CTA") and Managed Forex programs listed above are compiled from various sources, including Barclay Hedge, Attain Capital Management, LLC's ("Attain") own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.
The dollar based performance data for the various trading systems listed above represent the actual profits and losses achieved on a single contract basis in client accounts, and are inclusive of a $50 per round turn commission ($30 per e-mini contracts). Except where noted, the gains/losses are for closed out trades. The actual percentage gains/losses experienced by investors will vary depending on many factors, including, but not limited to: starting account balances, market behavior, the duration and extent of investor's participation (whether or not all signals are taken) in the specified system and money management techniques. Because of this, actual percentage gains/losses experienced by investors may be materially different than the percentage gains/losses as presented on this website.
Please read carefully the CFTC required disclaimer regarding hypothetical results below.
HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN; IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK OF ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL WHICH CAN ADVERSELY AFFECT TRADING RESULTS.