Ask any algorithmic trader what killed their first live strategy, and nine times out of ten the answer isn't the signal — it's the fill. Slippage is one of those costs that looks trivially small on paper and absolutely catastrophic in practice. Modelling it properly is genuinely hard, and most traders only discover that after they've already blown the edge.
The direct answer is this: if your backtest doesn't explicitly model slippage as a dynamic, volume-dependent cost — not a flat 0.1% assumption — your results are fiction. A strategy showing 40% annual returns in backtesting can become a 5% loser live, purely because fills never land where the theoretical model assumed they would.
Think of it like booking a flight you saw advertised for $199. By the time you add baggage fees, seat selection, and credit card surcharges, you're paying $340. The advertised price was real — it just wasn't the whole story. Slippage works the same way. The mid-price your backtest used was real. It just wasn't available to you when you actually pressed the button.
The right approach is to build a slippage model with three layers. First, half the bid-ask spread — because crossing the spread is unavoidable on market orders. Second, a market impact component tied to your order size as a fraction of average daily volume; the square-root market impact model is a widely used starting point here. Third, timing slippage — the cost of signal delay between trigger and execution. Stack all three, then stress-test the combined figure at two and three times your estimate before trusting the result.
For traders wanting to go deeper, the Investopedia explainer on slippage covers the mechanics cleanly, while Wikipedia's market impact article explains why large orders move prices against you. The broader algorithmic trading literature consistently shows that transaction cost modelling separates strategies that survive live markets from those that don't.
Paper-trade your strategy for at least 30 signals, record every actual fill versus expected price, and build your real slippage distribution from that data before risking capital at scale.
Your backtest is a map. Slippage is the terrain. The terrain always wins.
This content is for educational purposes only and does not constitute financial product advice. Past performance is not indicative of future results. Profit Logic Ltd (ACN 688 669 936) accepts no responsibility for errors or omissions in this content or anywhere on this website. Always seek advice from a licensed financial adviser before making investment decisions.