Adrian Reid explains why backtests fail without slippage and commissions. Many short-term systems look profitable until you add real trading costs. Test with increasing slippage values to find where your system breaks.
Have you ever seen a trading system published in a book or on a website or somewhere? And in fine print down the bottom it says results exclude slippage and commission. Well, if you've seen that and you've ignored it, now is the time to stop. Because this is one of my biggest bugbears about the trading industry. You see, it's ultra easy to develop an amazing looking trading system that performs super well in a backtest if you exclude slippage and commissions. But the fact is slippage and commissions are a part of trading life and you cannot escape it. Now, one thing that I've noticed, particularly in a lot of trading system books, is that huge numbers of authors publish short term trading systems excluding slippage and commissions. And the reason they do that is because when you add slippage and commissions in, most of those ultra short term systems look completely rubbish. And the backtest results degrade significantly, almost often to the point of being undeveloped. So if you're back testing and you're excluding slippage and commissions, you've got to change your habits. You've got to start being a bit more realistic about the way you evaluate your trading results. Early on in my backtesting process, when I'm working with students in the enlightened Stock Trader certification program, I encourage them to test with slippage and commissions to make sure that the edge the system generates is big enough to be actually profitable in the real world. If you don't do that, you're just deluding yourself. So in your backtest, whether you're using amibroker or any other trading software, you're going to add slippage and commissions to get a true sense for how profitable your system will be in the real world once all trading costs are taken into account. And don't forget, it's not just the brokerage. If you're trading small cap stocks, for instance, you've really got to account for some extra slippage in your backtest results because often when you get in and get out of small cap stocks, you're going to move the market just a little bit. And so slippage is a real thing in ultra liquid contracts, you, you know, the spy futures contract, many futures contracts and things like that, slippage is much less of an issue, but you still got to think about it depending on what your trading strategy is. So what I want you to do is if you have not back tested your trading results, your trading system with slippage and commissions, stop what you're doing, go to your trading software, crack it open, add some slippage and commissions and increase that slippage and commissions amount to more than what you actually paying in the market. Now what I like to do is step my slippage and commissions up gradually and see when the system breaks. If the system remains profitable well beyond where slippage and commissions are likely to be, then that gives me a high sense of confidence. So make sure you're taking this into account in your trading system. Now remember, if you haven't back tested your trading system, then that's the number one thing you've got to do. You don't even have a clue what what the profitability of your system is going to be until you back test it. So there are several other things that you need to do to build confidence in your trading system. So click the link below and download my Trading System Confidence Cheat sheet to make sure that you've ticked off all 11 steps that I take every time I develop and launch a new trading system to make sure I've got rock solid confidence that that system will work in real world trading. My name's Adrian Read. This is Enlightened Stock Trading and I hope to see you in the next video. Bye for now.
