Thought Calcuating slippage

Discussion in 'Strategy Development' started by ProgrammerGuy, Aug 30, 2007.

  1. I've been thinking about how to calcuate slippage. This way is not the way that other "pros" use, so I'm quite sure it is wrong, but i'd appreciate it if you could tell me where I am going wrong in my thinking.

    Currently I calcuate slippage the following way.
    ((Currentask - Currentbid) / CurrentBid) * 100; in percentage
    (Currentask - Currentbid) in dollar amounts

    When doing a backtest slippage must be considered because the historical prices are not likely what you are going to be filled at, however I'm probably wrong, but this is what I have been tihnking recently about slippage.

    We are trading Strategy A. We assume that strategy A WITHOUT slippage has a edge of 5 ticks. Now we have to apply a trim "normally called slippage" to account for the "not likely to get filled on historical data"

    So say stock ABC is priced at $50, Bid = $49.99, Ask = $50.01

    Historical tests say that we will have an edge of 5 ticks, so say we go long, we'll assume without slippage we'll buy at $50 and exit and $50.05

    Normally what I have been doing is taking (the Ask - the Bid) in this case (2) ticks (50.01 - 49.99) to come with a final estimate of my edge being (3) ticks. 5 ticks (From strategy) - 2 ticks of slippage

    So I place a market order at $50.01. My strategy has average 5 ticks of upward bias. My thinking is that the market will still go up 5 ticks + any help of movement. I moved the market .01 + .05 (5 ticks) will equal .06, assuming that on average this strategy will go to $50.06 because of the .05 from the strategy and the .01 from my order.

    So in this case, my thought process is that there is "no slippage" (or at least no reason to deduct) on the entry.

    Like if you place 1,000,000 shares moving the price from $50 to $50.20, is your slippage really .20?, because you were filled at 50.20, and the market price is 50.20. So now my thinking is your down NOTHING.

    Now if you decide to sell that is where you get the slippage so in the example
    1) the price is $50
    2) you increase the price to $50.01
    3) your strategy gets you to $50.06
    4) you sell and decrease the price to $50.05

    making your profit 50.05 - 50.01 (4 ticks) rather than 3 ticks.

    The guess the whole dilema of my thinking rests on whether you can assume that you expectation will go from $50 to $50.06, but I think that it can because your backtest said it'll move 5 ticks without any help. Now can you assume it's go 6 ticks because of the strategy and your order helping move the market then small tick.

    I'm sure this is incorrect thinking, but I just have to post this to "kinda get this out of my system"