How To Develop a Trading System Part 5

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Evaluating Systems – Commission and Slippage

This is going to be a relatively short post, for two reasons; 1) it’s super important and 2) it’s a super simple concept.

People who don’t declare slippage and commission in their strategies are incompetent, and giving you an incorrect impression of their system performance. Not just incorrect, but potentially account busting information. Virtually all, or I should say the vast majority of forex systems vendors don’t report slippage. That should tell you something.

Under NO circumstance should you put any validity in a system if slippage and commissions, and any other expense, is not computed into the results. If you do, then you are evaluating completely bogus performance data.

And the qualifier…the slippage should be realistic, perhaps overly pessimistic, and the commission should be accurate. In other words, the commission should reflect the actual commission you pay the broker for the types of trades you are evaluating.

These two factors, if not present in the system you are evaluating, could make all the difference between a system that looks wildly profitable, and a system that loses virtually every trade. THAT”S HOW IMPORTANT THIS IS!

CAUTION: Most people who supply automated trading systems, do not include slippage and commission, or they demonstrated there stuff without commission and slippage included, claiming it’s just for illustrative purposes. Look at this with EXTREME PREJUDICE!

Also, you should be asking how they determined slippage…

What did you say? What’s Slippage?

Oh, I’m so sorry…let me explain.

Slippage is the difference in the number of ticks between the Bid and the Ask. You will notice when observing the DOM or Matrix, which shows the Bid and Ask orders, and the current price of a security, that the Bid and Ask limits are one or more ticks apart.

This means that if you were to place a market order, the best possible price you will get filled at, will be where the current Ask is for a Long trade, and for a Short, it will be where the Bid is. It will almost always be 1 or two ticks, or more worse, than where the current price is.

Example TSLA

These few cents add up when you make lots of trades, especially if the security you are trading has a big spread between the Bid and Ask. TSLA is just such a stock, where it routinely has about 5 to 10 cents of spread. If you trade 100 shares of TSLA, then this will mean your trade is cutting your profit short by 5 to 10 per each side of the trade.

In other words, when you figure in slippage on TSLA with 100 shares, you need to overcome 10-20 cents of price movement before you can realize any profit. So, just to see 10 cents of profit, TSLA would have to move 30 cents.

Stocks like Apple have very little slippage, no more than a penny. I usually am pessimistic and account for a penny and a half for each side of the trade. That covers me, and night make my optimization not look as good, but that means the chances my real results are at least that good, will be much more realistic.

Don’t Forget to Figure in Commissions

Same deal with Commissions, the only difference here is depending on what your commission structure is, you may need to be pessimistic with that addition to cost as well, just to be on the safe side.

If you have any questions, please don’t hesitate to reply to this email, or look for my contact info under the support tab on the website:

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