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What Is Slippage And How Does It Impact Our Trading Success?

When studying investment basics, the term slippage has two applications. In general, it means having a trade executed at a price less favorable to the trader. Let’s look at the two areas where we may see this term used: 

An order is executed at a worse-than-expected price 

Stock and options 

Slippage occurs when there is an unexpected change in the bid-ask spread. If we place a market order to buy a stock at the “ask” it may get executed at a higher price. This is usually the result of a period of higher volatility, low trading liquidity or unexpected bad news. Let’s say the bid-ask spread for Company BCI was $31 – $31.25. If we placed a market order to buy 100 shares we would expect to pay $3125 + commissions. However, in a highly volatile market environment or if some bad news is reported about the company the spread may change against us and we pay $3200 + commissions or more. On the other side of the spread, if we placed a market order to sell 100 shares of BCI for $31 (the “bid”) we may end up generating $30.50 – commissions or less. 

Stop loss order 

Let’s say we purchased BCI for $32 and placed a stop loss order @ 10% or $28.80. This means that if the price reaches the stop price, the order will become a market order and sold at the best price of $28.80 or less. What if unexpected news came out regarding a disappointing earnings report and the share price gapped down to $26? The stop order is now a market order (unless otherwise specified) and our shares are sold for $2.80 less than we anticipated.

An order is executed at the published bid-ask spread 

The difference between the bid and ask prices is a normal aspect of trading. If the spread is $30-$30.50, the moment we buy the shares for $30.50 we can only sell for $30. That $0.50 difference is also called slippage as you are immediately at a 1.6% deficit. This is true of both stocks and options. 

How to minimize the impact of slippage in our accounts 

1- Favor stocks that have a significant daily trading volume. In my covered call writing accounts, my guideline is to require equities trading at 250,000 shares per day or more. In my longer term accounts, I favor equities trading at 500,000 shares per day or more (I will be introducing a long-term trading strategy for high school and college students in my upcoming 4th book). 

2- Favor options that have an “open interest” of 100 contracts or more and/or a bid-ask spread of $0.30 or less. In the chart below, we see that the January $50 calls for EBAY does meet our system requirements with 145 contracts of open interest and a bid-ask spread of $0.03:

option liquidity

Open interest and bid-ask spread

 

3- Avoid trading during volatile market hours. I avoid early morning and late afternoon trading. My favorite hours are between 12PM EST and 3PM EST. 

4- Negotiate your trade order price. I call it ‘playing the bid-ask spread” Place the limit order slightly below or above the midpoint of the spread (depending on if you are buying or selling), favoring the market maker. You’ll be amazed at how many orders will get filled at the better price. For tight bid-ask spreads ($0.10 or less) there is no room for negotiation.

Conclusion 

Slippage is a normal part of trading stocks and options. To maximize our returns we must execute all measures that will minimize the impact slippage has on our trading success.

 Market tone:

The last week of the year is typically a light trading volume week with few economic reports and this year was no exception:

  • The Conference Board’s index of consumer confidence (a gauge of consumers’ attitudes about the present economic situation as well as their expectations regarding future conditions. Consumer confidence tends to have a strong correlation with consumer spending patterns) came in @ 65.1 well below the 70.0 expected. However, perceptions of current economic conditions rose for the 5th straight month and stands at its highest level in 5 years
  • Sales of new residential homes rose 4.4% in November (from October) and stands @ 15.3% higher than a year ago
  • New home sales is at its highest level since early, 2010 when tax credit enhanced demand
  • The median price of homes rose to $246,200, a 15% increase from a year ago
  • Initial jobless claims for the week ending 12/22 came in @ 350,000 below the 360,000 expected

For the week, the S&P 500 dropped by 0.5% for a year-to-date return of 15.5%, including dividends.

Summary:

IBD: Uptrend under pressure

BCI: President Obama and Congress are negotiating for a last minute budget deal and that should determine the short-term performance of the market. This site is extremely bullish long-term but remains in a rare high-cash position, selling only in-the-money strikes with cash invested and using low beta stocks with ETFs.

Wishing you a happy, healthy and lucrative 2013,

Alan and the BCI team (alan@thebluecollarinvestor.com)

www.thebluecollarinvestor.com

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

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12 Responses to “What Is Slippage And How Does It Impact Our Trading Success?”

  1. Gail December 29, 2012 8:01 am #

    Alan,

    Do you have any rules for volume or just open interest? Thanks and happy new year.

    Gail

    • Alan Ellman December 30, 2012 9:53 am #

      Gail,

      I prefer OI over Vol because it is cumulative compared to being reset daily as is Vol and is therefore a better indicator of overall liquidity. So the BCI guideline is an OI of 100 contracts or more and/or a bid-ask spread of $0.30 or less.

      Alan

  2. Barry B December 29, 2012 5:01 pm #

    Premium Members,

    The Weekly Report for 12-28-12 has been uploaded to the Premium Member website and is available for download.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the BCI YouTube Channel link is:

    http://www.youtube.com/user/BlueCollarInvestor

    We have enhanced the Weekly Report…we incorporated a summary of the Weekly ETF Report. This should help save you time during your stock/ETF selection process.

    Best,

    Barry and The BCI Team

  3. Steve Z December 29, 2012 8:10 pm #

    Barry, I’ve been looking at the price charts for quite awhile now for your weekly stock list. This week’s list has two that I’m surprised made it: THO and especially SWI. I just thought I’d double-check that they belong in the list. Steve

    • Barry B December 29, 2012 9:08 pm #

      Steve,

      Thank you catching SWI. Actually the Stock Screen portion of the report properly handled SWI…it failed the price chart as well as the technicals and is in the “failed area” of the stock screen section. It didn’t translate/sort properly on the spreadsheet for the Running List. We will send out a revision immediately.

      As for THO,…
      – Passed IBD Screens
      – Stock Scouter grade of 7
      – Price Bar/Candle on the 20 EMA…acceptable
      – Positive MACD…acceptable
      – Stochastics…turned down below the “80” line…fail
      – Therefore…mixed technicals…acceptable…selection depends on
      your risk tolerence

      How did you find the new sunnary of the ETF report being incorporated into the Weekly Stock report?

      Best,

      Barry

  4. Barry B December 29, 2012 9:27 pm #

    Premium Members:

    This week’s Weekly Stock Screen And Watch List has been revised and uploaded to The Blue Collar Investor premium member site and is available in the “Reports” section. The Running List had a sorting error and has been corrected. The problem was related to a single stock. The Stock Screen Section is unaffected. Look for the report dated 12-28-12-REVA.

    For your convenience, here is the link to login to the premium site:

    https://www.thebluecollarinvestor.com/member/login.php

    Best,

    Barry and the BCI Team

  5. Steve Z December 29, 2012 9:33 pm #

    Barry, thanks for the quick response. I should have commented about the ETFs since I do like their addition into the report. The one suggestion I have would be to add that the returns are over a 3-month timeframe. I know this is in the ETF report but I normally try to make separate documents as stand-alone summaries whenever possible and returns are only meaningful if you know the timeframe.

    Keep up the great work!

    Steve

  6. Steve Z December 29, 2012 9:36 pm #

    FYI, I have absolutely no idea where the spreadsheet screenshot came from.

  7. Jorge December 30, 2012 3:26 am #

    Alan,

    In your article you talk about a long term strategy for students in a new book you’re writing. Is this also about covered calls? Good luck with the new book. I’ve read all the others.

    Jorge

    • Alan Ellman December 31, 2012 7:03 am #

      Hi Jorge,

      Thanks for your support and well-wishes. My new book is a long-term strategy involving mutual funds at first and then individual equities when certain cash levels are achieved. I introduce covered call writing at the end of the book for those willing to go the extra mile to enhance results to even greater heights. I’d say cc writing represents about 5% of the book. The remainder of the information will be new to the BCI community (but geared to the younger generation).

      Alan

  8. Barry B December 31, 2012 12:04 am #

    Premium Members:

    This week’s Weekly Stock Screen And Watch List has been revised and uploaded to The Blue Collar Investor premium member site and is available in the “Reports” section. The ETF section headings were modified to be more descriptive. The Stock Screen Section is unaffected and does not impact any stock or ETF selection decisions. Look for the report dated 12-28-12-REVB.

    For your convenience, here is the link to login to the premium site:

    https://www.thebluecollarinvestor.com/member/login.php

    Best,

    Barry and the BCI Team

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