Definition
Slippage Modelling
Slippage modelling is the quantitative estimation of expected execution costs, including spread, market impact and timing effects, so that a backtest or live strategy reflects realistic, achievable prices.
A credible Indian backtest does not assume fills at the mid-price. Instead it applies a slippage model, often a function of order size relative to average volume, the bid-ask spread, and volatility, to penalise each simulated trade. Linear and square-root impact models are common starting points.
Good slippage modelling matters most for high-turnover and small-cap strategies, where transaction costs can dwarf the raw signal. Underestimating slippage is a classic reason that a backtested quant strategy decays sharply in live trading; conservative cost assumptions are a hallmark of disciplined research.
Related terms
- Market ImpactMarket impact is the adverse price movement caused by the act of trading itself, where a large buy pushes the price up and a large sell pushes it down as the order consumes available liquidity.
- SlippageSlippage is the difference between the expected price of a trade and the price at which it is actually executed, arising from market movement, spread and limited liquidity between order placement and fill.
- Transaction Cost Analysis (TCA)Transaction Cost Analysis is the post-trade measurement of execution quality, comparing realised fill prices against benchmarks such as arrival price or VWAP to quantify explicit and implicit costs.
- BacktestingBacktesting is the process of simulating a trading strategy on historical data to estimate how it would have performed, including returns, drawdowns and risk, before committing real capital.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.