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No. of Recommendations: 4
platykurtic:
A couple of notes: Slippage is price paid / received including all fees vs. final closing price for the screen. Lag included.

IMO, this is an invalid definition of slippage. I recognize that there are many valid ways of estimating it, but if there is one rule that should be absolute, it's that the benchmark prices should be taken from before you entered your trades, not after. Otherwise, your benchmark prices are biased in your favor because they reflect the impact of your trades.

While your MOC order remains "dormant", in a sense, until the market closes, it is not invisible during that time (at least not to the market makers). Once the MOC order submission deadline passes, the market makers know your supply or demand are guaranteed, it is taken into account during the NYSE Closing Auction/NASDAQ Closing Cross (which is why the submission deadlines exist). While your trade gets reported after the close, it actually impacted the close--more so than a regular trade placed minutes before the close.

If it's too much trouble to take a real-time snapshot of all the stocks you're about to trade right before you trade them, then I'd suggest using the previous day's closing prices as your benchmark. Deviations from those prices will be huge, but on average, this will at least provide an unbiased estimate of your total implementation shortfall, which after all, is the only "friction" we really care about. Of course this would be a measurement of friction versus the zero-lag GTR1 backtests, not the one-day lag backtests that you are probably using. But once you have a good estimate of your friction versus the previous day's close, then you can start running zero-lag backtests with the unbiased friction value applied.

As it is now, your own trading of screens at one-day lag is impacting the forward tests of the screens at one-day lag in a manner that wasn't present in the backtest, so strictly speaking, those backtests are no longer relevant anyway. By definition, you can't impact the zero-lag forward tests, so the zero-lag forward tests remain consistent with the zero-lag backtests.

If you're interested in re-doing your friction estimates using previous-day closing prices, send me a list of the point-in-time ticker symbols that you traded (many of which will no longer exist) and I can probably get you the required data without much trouble. I also have same-day 15:30 and 15:45 closing prices handy on all stocks (back to 1990) as well.

It may well be that MOC orders produce less implementation shortfall than manually and frantically chasing thinly-trade stocks in the last fifteen minutes of the trading session, but your experiments provide no support for that conclusion because the same-day closing prices you've been using as your benchmarks have been contaminated by your own trades (whether you used MOC orders or not).

Robbie Geary
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