Measuring Slippage: Make it a Top Priority!
June 20, 2005
The computer reported a loss of -$800 for the R-Mesa system's trade last Thursday, but clients trading the system lost -$933 on the trade. What happened? Where did that extra $133 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.
Shouldn't these 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. True to form, the R-Mesa trade mentioned in the first paragraph was right at this number, coming in at $133.
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 reacting to price moves that it caused. 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, along
Attain slippage estimates:
Our estimates showed an average slippage of just over $145 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 electronically 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.
- Walter Gallwas
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.
Feature | Week In Review | Chart of the Week |
Feature | Week In Review | Chart of the Week |
It's a worry every year for day trading systems...that summer vacations and nice weather clear out the trading floors and cause intraday volatility to dry up. It's hard to make money when the market's aren't moving much, and last week definitely saw some signs of summer slowness. S&P futures tacked on 1.37% for the week.
Elsewhere, Crude Oil continued its meteoric rise last week, + 8.23%, despite Gasoline inventories (supply) at their highest levels in a few years. It turns out a lot of refineries were so worried about running out of gasoline, they built up those inventories at the cost of Diesel and other types of fuels. The low supply of these distillate fuels has driven their prices higher and helped Crude stay aloft.
Also seeing gains last week were the grain markets, which continue to climb away from historically low prices thanks to talk of drought conditions in the Midwest. Soybeans were the largest gainer rising 9.00%, followed by corn which rose +7.77% and wheat which rallied +4.01%.
And finally, the EC gained +1.31% last week as the US Dollar (-1.18%) came off its recent highs.
**Day Trading**
Small daily ranges and the majority of any moves happening in the overnight session were not a good combination for day trading systems last week as a wide array of day trading systems saw losses for the week.
System showing profits included Clipper eRL with $83.80 in profits per emini Russell and Magnitude ES with $37.50 in gains per emini S&P contract. Clipper's sister system Compass didn't fare as well, losing -$1,720 on 3 trades last week, while Magnitude ES's fellow Founder Trading systems Cipher ES and Helix ES lost -$120 and -$462.50 respectively.
The Blue Wave Trading suite of systems didn't fare much better, with BWT Zones SP losing -$720 for the week on four trades, BWT Zones eRL losing -$1,152.50, and BWT Rock'n Russell losing -$2,629.10.
Elsewhere, R-Mesa continued its 2005 struggles, losing -$1,133 on two trades, while Daybreaker lost -$750. AG Xtreme followed suit, losing -$225.
Rounding out last week's activity, RC Success ES and RC Miracles ES lost -$245 and -$950 respectively per emini S&P contract.
**Swing Trading**
While the day trading systems struggled, swing trading systems took advantage of the slow crawl upwards last week, as most entered the week long US stock indices.
The trades of the week went to Eclipse eRL and Axiom eRL, as both hit profit targets during the Russell's move higher last week. Eclipse eRL made $3,831.70 on the closed out trade, then reestablished a long position just a few hours later.
Axiom eRL hit its built in 40 point profit target, making $3,921.70 after commissions on the closed out trade, and remains flat in that market. In other markets, Axiom continues to struggle in the ES market, losing -$662.50 there, while it made $90 in the Nasdaq last week, and continues to hold long in the eMD market for open trade profits of $1,750 on the current leg of the trade (after making $1,090 on the first leg of the trade closed out last week to roll to the new front month contract)
Tzar, meanwhile, didn't view last week's action as anything to get excited about, holding long in the Nasdaq and Mid Cap. Mesa Bonds, meanwhile, locked in profits on its short bond position by reversing back to a long position, making $1,668 on the closed out trade.
**Long Term**
Long term, trend following systems may finally be turning back to the positive side after posting some more solid numbers last week.
The trade of the week for trend followers went to Andromeda, which exited its long Euro Currency position on its $10,000 profit target. The system made $9,493.75 per contract on the closed out trade. (See article on slippage below for discrepancy between $10K and actual profit). Andromeda was active in other markets as well, initiating long trades in Platinum and Bean Oil while putting on a short trade in Coffee. The system did take a loss -$1,670 per contract when exiting a short Gold position last week.
Elsewhere, Aberration exited a short Canadian Dollar position for a loss of -$570, while entering short in the Cattle market, and Axiom LT is the only long term system participating in the Crude rally, with an open long position making $2,530 per contract in open trade profits as of last Friday (and a little more than that after today's +1.77% rally). Axiom LT is also short the Cattle, while continuing to hold long in 30 yr and 10 yr bonds.
Finally, SEMA4 Symmetry continues to improve, seeing $1,862 in open trade profits on a short Japanese Yen trade, but losing -$1,650 in open trade losses per contract on a long Cattle position.
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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.