Slippage: the gap between a decision price and an execution price

Slippage is the difference between the price a strategy assumed when it decided to trade and the price it actually achieved once the order was filled. It is an implicit cost: nothing is paid to a counterparty labeled "slippage" on a confirmation, but the return actually captured is the execution price, not the decision price, and the gap between them is real.

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 \(s\) means the strategy paid more than the price that justified the trade; for a sell, the sign convention flips, since paying less than the decision price is the unfavorable outcome. Aggregated across an order or a strategy, slippage is usually reported as a volume-weighted average in basis points.

Two sources, not one

Slippage is commonly split into two components. Market impact is the price movement caused by the order itself: a large order consumes available liquidity and moves the price against the trader as it executes. Delay cost is the price movement that happens for unrelated reasons between the decision time and the time the order is actually placed or completed, including the case where part of an order goes unfilled and the opportunity is priced at whatever the security does afterward.

Separating the two matters because they respond to different fixes. Market impact is addressed by trading more slowly, splitting orders, or trading in more liquid names; delay cost is addressed by shortening the time between a signal firing and an order reaching the market. A backtest that only subtracts a flat basis-point assumption cannot distinguish between them, and an estimate calibrated on a low-turnover strategy will understate slippage for a strategy that trades more urgently or in less liquid names.

Why it compounds with turnover

A slippage estimate that looks small per trade can matter a great deal for a strategy that reallocates frequently. The same turnover that determines explicit transaction-cost drag also determines how many times a strategy pays slippage over a year, so the two costs should be evaluated together rather than as separate footnotes to a backtest's headline return.

Further reading

• André F. Perold, “The Implementation Shortfall: Paper Versus Reality”, The Journal of Portfolio Management, 1988. Introduces the implementation-shortfall framework that decomposes the gap between a paper portfolio and a real one, of which slippage is a central component.