Kick the (Slippage) Tires before investing in a Trading System

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Kick the (Slippage) Tires before investing in a Trading System

Posted On : Dec-09-2010 | seen (551) times | Article Word Count : 1131 |

With the constant modernizing of the world we live in, where one can deposit checks via their mobile phone, download running statistics from their shoes, and order nearly anything they can think of online - it seems easier and easier to forget to be the careful consumer who kicks the tires and checks under the hood these days.

We’re used to seeing a nice brand name product on websites and clicking the nice shiny button to purchase it, and that is definitely the way the investing world is going. But the big difference between buying a Kindle off of Amazon.com and an automated trading system off of some slightly lesser known website is the quality control and “picture” of the product.

With Amazon.com, you’re going to get the very product you see in the picture on the webpage you click ‘buy’ on. With any trading system or ‘follow the guru’ website you buy off of, where the product ‘picture’ is the performance data and graph, you are going to get something very different.

Consider the following disclaimer on one of the websites we came across:

“………. does not, by default, include commissions and execution costs when displaying hypothetical results. These costs will certainly make your actual trading results worse than the results you see here. For high-frequency trading systems, your results will be vastly worse than the results you see here.”

Why would they choose to show you a ‘picture’ of the product which is “vastly” better than the product you will actually receive? Could it be because they would sell much less of the “vastly worse” product? Consider the following example, where we received a system from an aspiring developer a while back in which the past year’s hypothetical profits were reported as $106,400; but which came out to -$24,625 for the same time period when we did the testing with our own slippage and commission numbers included. In seeing this example of just how large “vastly worse” can be, it sure seems like the reason centers around getting more ‘Buy Now’ clicks.

What is Slippage?

So what is slippage? And why is it so important to commodity trading system performance? When a system is being traded in real time by a live person, slippage is the difference between where a computerized trading system thinks it got filled, and the actual fill received by someone following that system. When we’re talking about running a computerized trading system’s code back in time on historical data, slippage is a small adjustment made to each trade in that backtest which is meant to simulate the difference between where the computer signals a trade entry and where actual clients, with actual money, would have entered and exited the market using the computer's signals.

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, and that is what many unscrupulous brokers and others selling trading systems would like for you to believe; but the truth is that 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 is 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 emini S&P 500 futures market is around 1 tick or 1/4 of a full point. Slippage on a market or stop order in the emini S&P, therefore, can be estimated to be 1/4 a full point, or 1 ticks, or $12.50 per side, and $25 per R/T (two sides). In a market like Palladium with much less volume, the spread between the bid and ask may be something more like 20 ticks and you could be looking at upwards of $100 in slippage per side.

There is also the size of your order to consider. Consider again the emini S&P futures, which have thousands of contracts bid and offered on each side of the last price at seemingly all times of the day. In such a case, hundreds of contracts could be done at the bid or offer price without the market having to rise or fall to find additional takers for your order. Contrast that with the aforementioned Palladium market, whereby there may be only 10 contracts or so bid and offered within a handful of ticks of the last price. Doing 100 contracts in that case would mean the market would need to move up or down (depending on whether you are trying to buy or sell) to find more bids and offers to fill your order. The less contracts that are bid or offered at each level, the more the market needs to move to fill your multiple contract order.

The good news is that slippage can be fully accounted for in backtesting, and fully measured in real-time (making it even more suspect when someone trying to sell you a system doesn’t show performance including slippage). So before you invest hard earned money with a trading system, make sure you ‘kick the slippage tires’ a bit to see what the performance is after slippage has been considered.

- Walter Gallwas

Walter Gallwas is a founding partner and President of Attain Capital Management (AttainCapital.com). Attain has analyzed and reviewed 1000s of trading systems and managed futures programs, authored 400 (and counting) articles and research reports on trading systems and managed futures spanning over 1,600 pages, and have assisted clients in investing over $300 Million into trading systems and managed futures since 2002.

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<h1>Kick the (Slippage) Tires before investing in a Trading System</h1> Author: <a href='http://www.articleseen.com/profile_Jeff Malec.aspx'>Jeff Malec</a> With the constant modernizing of the world we live in, where one can deposit checks via their mobile phone, download running statistics from their shoes, and order nearly anything they can think of online - it seems easier and easier to forget to be the careful consumer who kicks the tires and checks under the hood these days.

We’re used to seeing a nice brand name product on websites and clicking the nice shiny button to purchase it, and that is definitely the way the investing world is going. But the big difference between buying a Kindle off of Amazon.com and an automated trading system off of some slightly lesser known website is the quality control and “picture” of the product.

With Amazon.com, you’re going to get the very product you see in the picture on the webpage you click ‘buy’ on. With any trading system or ‘follow the guru’ website you buy off of, where the product ‘picture’ is the performance data and graph, you are going to get something very different.

Consider the following disclaimer on one of the websites we came across:

“………. does not, by default, include commissions and execution costs when displaying hypothetical results. These costs will certainly make your actual trading results worse than the results you see here. For high-frequency trading systems, your results will be vastly worse than the results you see here.”

Why would they choose to show you a ‘picture’ of the product which is “vastly” better than the product you will actually receive? Could it be because they would sell much less of the “vastly worse” product? Consider the following example, where we received a system from an aspiring developer a while back in which the past year’s hypothetical profits were reported as $106,400; but which came out to -$24,625 for the same time period when we did the testing with our own slippage and commission numbers included. In seeing this example of just how large “vastly worse” can be, it sure seems like the reason centers around getting more ‘Buy Now’ clicks.

What is Slippage?

So what is slippage? And why is it so important to commodity trading system performance? When a system is being traded in real time by a live person, slippage is the difference between where a computerized trading system thinks it got filled, and the actual fill received by someone following that system. When we’re talking about running a computerized trading system’s code back in time on historical data, slippage is a small adjustment made to each trade in that backtest which is meant to simulate the difference between where the computer signals a trade entry and where actual clients, with actual money, would have entered and exited the market using the computer's signals.

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, and that is what many unscrupulous brokers and others selling trading systems would like for you to believe; but the truth is that 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 is 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 emini S&P 500 futures market is around 1 tick or 1/4 of a full point. Slippage on a market or stop order in the emini S&P, therefore, can be estimated to be 1/4 a full point, or 1 ticks, or $12.50 per side, and $25 per R/T (two sides). In a market like Palladium with much less volume, the spread between the bid and ask may be something more like 20 ticks and you could be looking at upwards of $100 in slippage per side.

There is also the size of your order to consider. Consider again the emini S&P futures, which have thousands of contracts bid and offered on each side of the last price at seemingly all times of the day. In such a case, hundreds of contracts could be done at the bid or offer price without the market having to rise or fall to find additional takers for your order. Contrast that with the aforementioned Palladium market, whereby there may be only 10 contracts or so bid and offered within a handful of ticks of the last price. Doing 100 contracts in that case would mean the market would need to move up or down (depending on whether you are trying to buy or sell) to find more bids and offers to fill your order. The less contracts that are bid or offered at each level, the more the market needs to move to fill your multiple contract order.

The good news is that slippage can be fully accounted for in backtesting, and fully measured in real-time (making it even more suspect when someone trying to sell you a system doesn’t show performance including slippage). So before you invest hard earned money with a trading system, make sure you ‘kick the slippage tires’ a bit to see what the performance is after slippage has been considered.

- Walter Gallwas

Walter Gallwas is a founding partner and President of Attain Capital Management (AttainCapital.com). Attain has analyzed and reviewed 1000s of trading systems and managed futures programs, authored 400 (and counting) articles and research reports on trading systems and managed futures spanning over 1,600 pages, and have assisted clients in investing over $300 Million into trading systems and managed futures since 2002. About the Author: Copyright 2010 <a rel="nofollow" href="http://www.attaincapital.com/">Attain Capital Management</a>, licensed <a rel="nofollow" href="http://www.attaincapital.com/alternative-investment-performance/managed-futures/recommended-ctas/page1">Managed Futures</a>, <a rel="nofollow" href="http://www.attaincapital.com/alternative-investment-performance/trading-systems/recommended-systems/page1">Trading System</a> & Commodity Brokers. All Rights Reserved. Reprinted with permission. Article Source: <a href='http://www.articleseen.com/Article_Kick-the-(Slippage)-Tires-before-investing-in-a-Trading-System_44616.aspx'> http://www.articleseen.com/Article_Kick the (Slippage) Tires before investing in a Trading System_44616.aspx</a>

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Keywords : Attain Capital Management, licensed Managed Futures, Trading System, Commodity Brokers,

Category : Finance : Finance

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