Introducing: The Slippage Project

Now that PDS has successfully launched, I want to direct some attention to a brand new project, one that has the potential to benefit a large number of traders. It is called The Slippage Project. This project will rely on crowdsourcing to quantify the average amount of slippage¹ one incurs when using market orders on the open. Before I get into the specifics of how this project will be implemented, some background information is necessary.

What Is the Opening Auction or Opening Cross?

When one places a market order to be executed at the next open (market-on-open or MOO), he or she is agreeing to participate in the opening auction or opening cross. In simple terms, during the opening auction, the stock exchange runs an algorithm (at least on the Nasdaq) and attempts to match buy orders with sell orders. If there is an imbalance such as more buy orders than sell orders, the stock will gap up as there is more demand than supply.

Link to NYSE Arca Equities Opening Auction

Link to How Nasdaq’s Opening and Closing Cross Works (Highly recommended reading).

When we agree to participate in the opening auction or cross, we accept that we will get the opening price. However, and this is very important, there can actually be different opening prices for each security!

The Official Exchange Open vs. The Consolidated Open

When a stock opens for trading at 9:30 a.m., the cross that takes place on the major exchange, e.g., the NYSE or Nasdaq, is recorded as the Official Open price.  While the Nasdaq is very quick at crossing trades, the NYSE is very slow, primarily because the Nasdaq is an electronic exchange while the NYSE is still suffering from the remnants of the specialist system. If a trade goes through an ECN before the opening cross is finished (this happens often on the NYSE, remember it is slow) the ECN trade is recorded as the consolidated open. For example, while the NYSE is busy counting on their fingers and toes, trying to match orders for ABC stock, an ECN may match a trade at 9:30:01 a.m. (making the consolidated open). ABC stock may not officially be opened by the NYSE until 9:31:00 a.m, and when it does open, the official open price is recorded.

So to recap, we have an official open price, and a consolidated open price. The problem is that on the NYSE, the two prices are usually different!

To make matters worse, most data providers, including Yahoo, Google, Tradestation, Interactive Brokers, etc. publish the consolidated open price, and NOT the official open. And here is the critical point: Most retail traders could never actually get the consolidated open price, only the official open price. Yet the consolidated open is what is commonly reported.

The Problem, and a Solution

The problem is that we are presented with an opening price that is unattainable.

When we backtest strategies that trade the open or the close ( more on trading the close later), we are assuming that we could have purchased a stock at a price that would not have been obtainable in the real world.

For strategy traders, if on average we are filled at a price higher than the consolidated open, it will mean that our strategy may not perform as well as it did during backtesting. Similarly, if we consistently get filled beneath the consolidated open, it will mean that our strategy may actually exceed the performance results derived from backtesting.

The solution is to record hundreds if not thousands of opening buys and sells, and calculate the differences between the official opens and the consolidated opens. After recording enough opening prices, we can determine a realistic figure to use during backtesting.

My friend BHH and I started recording  our opening trades, some time ago (credit must go to him for the idea). When we stopped logging trades, we were actually seeing a positive difference, meaning that on average we were getting filled at prices lower than the published opens.

Tito over at Hack the Market wrote about a similar project where he logged roughly 850 trades, and saw a price improvement of  .04% on the trades where he was not filled at the published open.

For us strategy traders that trade the open or the close, this information is invaluable. We may be seeing positive price improvements that will negate the cost of commissions, or not. The alternative is that we should be building higher costs into our systems to account for negative slippage.

Implementation

I do not want any exploding heads, so implementation of the project will be discussed in the next post. Stay tuned! This is a project that will benefit many of us retail traders, but in order for it to be successful, we will all have to participate!

¹ This is not slippage in the traditional sense of the term Rather, we are talking about the difference between the official and consolidated opening prices.

Introducing: The Slippage Project

Now that PDS has successfully launched, I want to direct some attention to a brand new project, one that has the potential to benefit a large number of traders. It is called The Slippage Project. This project will rely on crowdsourcing to quantify the average amount of slippage¹ one incurs when using market orders on the open. Before I get into the specifics of how this project will be implemented, some background information is necessary.

What Is the Opening Auction or Opening Cross?

When one places a market order to be executed at the next open (market-on-open or MOO), he or she is agreeing to participate in the opening auction or opening cross. In simple terms, during the opening auction, the stock exchange runs an algorithm (at least on the Nasdaq) and attempts to match buy orders with sell orders. If there is an imbalance such as more buy orders than sell orders, the stock will gap up as there is more demand than supply.

Link to NYSE Arca Equities Opening Auction

Link to How Nasdaq’s Opening and Closing Cross Works (Highly recommended reading).

When we agree to participate in the opening auction or cross, we accept that we will get the opening price. However, and this is very important, there can actually be different opening prices for each security!

The Official Exchange Open vs. The Consolidated Open

When a stock opens for trading at 9:30 a.m., the cross that takes place on the major exchange, e.g., the NYSE or Nasdaq, is recorded as the Official Open price.  While the Nasdaq is very quick at crossing trades, the NYSE is very slow, primarily because the Nasdaq is an electronic exchange while the NYSE is still suffering from the remnants of the specialist system. If a trade goes through an ECN before the opening cross is finished (this happens often on the NYSE, remember it is slow) the ECN trade is recorded as the consolidated open. For example, while the NYSE is busy counting on their fingers and toes, trying to match orders for ABC stock, an ECN may match a trade at 9:30:01 a.m. (making the consolidated open). ABC stock may not officially be opened by the NYSE until 9:31:00 a.m, and when it does open, the official open price is recorded.

So to recap, we have an official open price, and a consolidated open price. The problem is that on the NYSE, the two prices are usually different!

To make matters worse, most data providers, including Yahoo, Google, Tradestation, Interactive Brokers, etc. publish the consolidated open price, and NOT the official open. And here is the critical point: Most retail traders could never actually get the consolidated open price, only the official open price. Yet the consolidated open is what is commonly reported.

The Problem, and a Solution

The problem is that we are presented with an opening price that is unattainable.

When we backtest strategies that trade the open or the close ( more on trading the close later), we are assuming that we could have purchased a stock at a price that would not have been obtainable in the real world.

For strategy traders, if on average we are filled at a price higher than the consolidated open, it will mean that our strategy may not perform as well as it did during backtesting. Similarly, if we consistently get filled beneath the consolidated open, it will mean that our strategy may actually exceed the performance results derived from backtesting.

The solution is to record hundreds if not thousands of opening buys and sells, and calculate the differences between the official opens and the consolidated opens. After recording enough opening prices, we can determine a realistic figure to use during backtesting.

My friend BHH and I started recording  our opening trades, some time ago (credit must go to him for the idea). When we stopped logging trades, we were actually seeing a positive difference, meaning that on average we were getting filled at prices lower than the published opens.

Tito over at Hack the Market wrote about a similar project where he logged roughly 850 trades, and saw a price improvement of  .04% on the trades where he was not filled at the published open.

For us strategy traders that trade the open or the close, this information is invaluable. We may be seeing positive price improvements that will negate the cost of commissions, or not. The alternative is that we should be building higher costs into our systems to account for negative slippage.

Implementation

I do not want any exploding heads, so implementation of the project will be discussed in the next post. Stay tuned! This is a project that will benefit many of us retail traders, but in order for it to be successful, we will all have to participate!

¹ This is not slippage in the traditional sense of the term Rather, we are talking about the difference between the official and consolidated opening prices.