Slippage: Live Trading | Definition, Example, and Real-Time Scenarios
Slippage is probably the enemy number one for short-term traders. What is slippage in live trading and how much slippage can you expect to have in live trading? What is slippage in real trading?
Slippage in trading is a hidden cost that is difficult to quantify. It’s the difference between a theoretical price and the price you get in live trading. In this article, we provide you with facts about slippage in live trading in a select choice of three different ETFs. Slippage is most likely lower than you realize.
First, let’s define what slippage in trading is:
What is slippage in trading?
Slippage is the difference between fictional results when backtesting strategies and the actual results in real life adjusting for commissions and transaction costs. It’s a “hidden” cost and is based on the transaction.
For example, a backtest might simulate an entry price of 38.09, but in live trading, you get a price of 38.1. This means you get a worse price in live trading (assuming you bought the asset). This difference might not sound much, but done many times, it can amount to significant amounts of money over a year.
Another example: If your backtest 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!
Slippage is not the same as commissions. 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.
Our experience tells us that the backtest results are always worse than real trading. But by how much?
It depends on the assets and strategies you are trading. SPY (S&P 500) has significantly less slippage than SIL (Silver Miners), for example, and breakout strategies are more costly to chase than mean reversion. It boils down to several factors. Thus, just using an arbitrary number like 0.1% or 0.05% doesn’t make much sense, in our opinion. Please read the link above to commissions in trading. We have established that we pay around 0.025% for a round trip in QQQ and SPY – including both commissions and slippage.
An example of slippage in trading – real trading
Let’s assume you want to buy shares in Apple. Apple might have a bid of 172.05 and an offer at 172.12. If you want to buy Apple you have to hit the offer at 172.12 or put in a lower bid. If you bid 172.07, for example, you risk not getting any shares unless someone hits your bid.
Slippage in trading is a hidden cost that a backtest can’t capture. When we backtest strategies, we always assume a negative slippage to allow for a margin of safety. We always expect live trading to have a negative slippage, but we also assume that the strategy gets worse over time.
Why is there slippage in trading?
There are mainly two factors determining the slippage in a trade:
Volume is the main determinant of slippage
The most important factor is probably volume. The more volume in an instrument, the tighter the spreads (the difference between the bid and the ask).
However, even high volume might not stop an asset from having high spread: