The spread and slippage
At any moment there are two prices, not one. Someone will buy from you at $49.98 (the bid) and someone will sell to you at $50.02 (the ask). The four cents between them is the spread, and it’s the price of doing business.
Buy and immediately sell, and you’re down four cents a share having done nothing at all.
Slippage is the related cost of moving: between the moment your strategy decides and the moment the order fills, the price has drifted. Sometimes in your favour. On average, not.
Why it matters more than it sounds
Four cents on a $50 stock is 0.08%. Trivially small. Now do it often:
| Trades per year | Round-trip cost at 0.08% each way |
|---|---|
| 10 | 1.6% |
| 50 | 8% |
| 200 | 32% |
A strategy that trades 200 times a year needs to make 32% before it breaks even — and that’s before commissions or tax. This is the single biggest reason that fast-trading strategies which look brilliant on paper don’t survive contact with a real broker.
What makes it worse
- Thin stocks. A widely traded company might have a one-cent spread. A small one can be 2% wide.
- Size. If your order is large relative to what’s on offer, you eat through several price levels.
- Speed. The faster you need to be out, the worse the price you’ll accept.
- The open and the close. Spreads are widest when the market is most uncertain, which is exactly when your stop is most likely to trigger.
The practical upshot
Two habits are worth building early.
Prefer strategies that trade less. Not because patience is a virtue, but because every round trip is a toll and fewer trips means less toll.
Be suspicious of any backtest result that depends on trading frequently. Most backtests fill at an idealised price and charge nothing for the privilege. If a strategy makes 40 trades a month and shows a 12% annual return, the spread may well have eaten all of it before you started.