Slippage: measuring decision-to-execution costs

Slippage is the difference between the price used to make a trading decision and the price achieved in execution. An unfavorable difference reduces the return available from the investment idea, making slippage an essential input to backtests and trading-cost estimates.

This article defines the buy and sell conventions, explains market impact and delay costs, and connects slippage to portfolio turnover.

Definition

For an order to buy, a simple slippage measure relative to the decision price \(P_{\text{decision}}\) and the volume-weighted average execution price \(P_{\text{exec}}\) is

\[s = \frac{P_{\text{exec}} - P_{\text{decision}}}{P_{\text{decision}}}.\]

For a buy, positive \(s\) records an unfavorable execution. For a sell, the numerator is reversed so that a lower execution price also produces positive slippage. At the order or strategy level, slippage is usually reported as a volume-weighted average in basis points.

Components of slippage

Market impact and delay cost make up slippage. Market impact is the price movement caused by the order: a large order consumes available liquidity and moves the price against the trader as it executes. Delay cost is the market movement between the decision and execution times. It also covers the opportunity cost of an unfilled order.

Each component calls for different controls. Slower execution, smaller child orders, and more liquid securities reduce market impact. Faster signal processing and order submission reduce delay cost. A flat basis-point charge ignores these differences and gives poor estimates when urgency, turnover, order size, or liquidity changes.

Slippage and turnover

A strategy incurs slippage on every unit of capital traded, so annual drag grows with turnover. Backtests should apply explicit transaction costs and slippage to the same turnover assumptions and report their combined effect on return.

Further reading

• André F. Perold, “The Implementation Shortfall: Paper Versus Reality”, The Journal of Portfolio Management, 1988. Introduces the implementation-shortfall framework for measuring the return lost between a portfolio decision and its execution.