How Much Slippage is Too Much?

That's the question you should be asking yourself as you create strategies.

Here's how you determine how much is too much.

Let's say in your backtest, your average profit per trade is $100.

Remember, this $100 of average profit assumes ideal execution.

That is, you don't miss any trades, and you get your full size at perfect prices.

Of course, this won't happen in reality, but it serves as the goal to achieve with every trade the strategy makes.

When you sum up all slippage over a period of time and convert it to average slippage per trade across the entire backtest, at what level would the strategy be not worth trading?

Let's say you summed up all slippage, and it accounted for $25 per trade. You're left with $75 average profit per trade.

What would the equity curve look like if every trade had $25 less in profit?

It would look worse - but how much worse?

Now imagine slippage sums up to $50 per trade, on average.

The curve will look even worse.

Continue until you determine your cutoff - what level of slippage you'd need to see such that the strategy wouldn't be worth trading.

Now you have a pre-planned benchmark to compare against when you start trading the strategy live.

Next time I'll discuss measuring slippage in your live trades so you can compare...

-Dave

P.S. WEBINAR ALERT - A few weeks ago, I gave a presentation for SMB Capital on the Bionic Trader webinar titled How to Avoid Curve Fitting. In case you missed that, Interactive Brokers has invited me to give the talk on April 16th at 2pm ET. Registration is below. I hope to see you there: