1
Explicit cost
Commissions, exchange fees, and regulatory charges are directly deducted.
Lesson · Backtesting and Trading Systems
Transaction Costs, Spread, Slippage, and Liquidity
Deduct commissions, fees, bid-ask spread, slippage, and size-dependent market impact from every simulated entry, exit, and rebalance.
Core concepts
What to understand
Keep each definition operational so it can be implemented and tested.
2
Spread and slippage
The executable price differs from the chart midpoint or signal price.
3
Market impact
Larger orders can consume available liquidity and move the average fill.
Interactive lab
Gross Versus Net Performance Lab
Increase turnover, spread, slippage, and order size. Compare gross and net equity curves.
Gross Versus Net Performance Lab
Deterministic synthetic educational data · no live market connection
BACKTEST MODEL
Process
Charge costs at the event
Do not subtract an arbitrary amount only at the end.
Estimate
Define instrument- and regime-specific cost assumptions.
Apply
Charge both entry and exit, including partial fills and rebalances.
Stress
Retest with wider spreads, higher volatility, and lower liquidity.
Knowledge check
Check your understanding
Select one answer for each question. Feedback appears immediately.
1. A round trip normally crosses costs:
Each executed side can incur fees, spread, and slippage.
2. Which strategy is most sensitive to small per-trade costs?
Frequent small edges can be fully consumed by execution costs.
3. Market impact generally becomes more relevant when:
Capacity is constrained by the volume available near the desired price.
4. Commission 1 bps, spread 8 bps, slippage 5 bps per side and impact 2.2 bps, against a 14 bps gross edge per trade. The net edge per trade is:
1 + 8 + 2 × 5 + 2.2 = 21.2 bps per round trip; 14 − 21.2 = −7.2 bps. The lab's range setting shows what 90 trades of that do to an account.
Practical rules
- Report gross and net performance separately.
- Use conservative costs for stressed conditions.
- Measure turnover and capacity with the tested order size.
Common mistakes
- Using midpoint prices for every fill.
- Applying costs only to losses.
- Assuming zero slippage in volatile or illiquid markets.
References
Official reading
The labs are simplified simulations. These sources cover historical performance, data, costs, or execution limitations.
Investor.gov · Understanding Fees
Reviews how fees and trading costs reduce investment results over time.
FINRA · Common Questions About Online Trading
Explains that market orders can fill away from quoted prices and limit orders may not execute.