Slippage - A Winning Strategy Can Lose Money

An algo-trading strategy currently being worked on shows promise. Optimising the rule with a genetic algorithm has given the trading rule a predicted yield of 10% but we can't expect to make that level of profit.

The rule is optimised with an opening position based on the lastpricetraded figure given by Betfair's API-NG. We don't expect to open our position at the ideal opening price due to slippage. In slippage the price slips away from the ideal to a less ideal price. This slippage is due to the spread moving as other arbitrageurs move ahead of us to take all of the volume at the price we wanted.

An exchange is a dynamic place with backers and layers continually entering the market, which means that the spread is often moving due to market agents taking what they believe is an ideal price. The price at which a trading rule opens a position may already be gone by the time the order is placed on the exchange. An open order may have to be changed to take a less optimal price. In other words the price has slipped away from the ideal price.

So long as the new price is only a tick or two off the ideal opening price then the overall position will only be worth about 1% less than the predicted value. This means that the hoped for 10% will now be at around 9%. In this case a 1% loss of yield is not a problem.

The problem comes when you are trading on very narrow margins with a rule that only yields 1% and you are trading close to the start of a race where the prices move more dynamically. In that situation a trading rule with an expected yield of 1% can easily have a negative yield when live trading.

To take account of slippage it is recommend that you record all your trades. Note the price that the rule is fired at and the price at which you place your trade. The difference between the two prices is your slippage value from which you can calculate the percentage loss. You can then determine if slippage is the cause of your trading rule not profitting as much as predicted.

2 comments:

  1. This is something that doesn't get a lot of mention in the blogs and as you rightly point out it has a big impact. A related aspect is the bet/trade size. A lot of blogs tell people new to the game to start small, give it a try with small stakes and if you find you're winning, simply increase the stakes to make bigger profits. Profits may indeed increase but your yield may diminish and there is likely a tipping point at which increasing stakes further reduces overall profitability. It's important to find that tipping point and optimal bet size for your strategy. The reason is simple; the profitability of every trade is predicated on the ability to get your trade matched at the price requested. The higher the bet/trade value the more chance it will not be fully matched at that price, or indeed matched at all.

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    Replies
    1. Very true.

      You are touching upon Market Capacity, which I discuss in http://www.betfairprotrader.co.uk/2013/01/market-capacity.html

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