From the August 01, 2011 issue of Futures Magazine • Subscribe!

Measuring and avoiding slippage

Long-term solution

Slippage might be considered an after-thought in developing a trading system. However, the results of this test suggest that slippage can be a major contributor to the overall system performance. Slippage impact usually is proportional to the trading frequency of a system. Therefore, one of the simplest ways to limit slippage while developing a trading system is to increase the time frame of the strategy.

Going back to the Donchian breakout system, we can test the effects of slippage when trading it at a much higher breakout period. "Expanding lookback" (below) shows the results of a test that simulates the system trading with a 100-day breakout period (50-day for exits) over the same portfolio, for a range of slippage between 0% and 35%.

One reason for the reduction in slippage is that the number of trades drastically decreases (compared to the 20-day breakout system), while trade length increases. The average trade duration is 119 days, while the average winning trade lasts 203 days.

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Slippage obviously still has a detrimental impact on performance. However, its effect is felt much less than with the 20-day breakout system. The system keeps producing positive results across the whole slippage-stepped simulation. The MAR is halved between the 0% slippage and 35% slippage cases, which is small relative to the reduction in the 20-day system.

Note, however, that this test does not reflect the effects of rollover slippage. Longer duration trades accrue rollover slippage when you transfer the position from one contract to the next. A trade lasting one year potentially could involve buying and selling 12 times (if the position is moved to another contract each month). However, rollover slippage usually is lower than entry/exit slippage, as it is less subject to the price momentum that generated an order in the first place.

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