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How large should transaction costs be for backtesting futures?
The point I made earlier about costs was that that can be used to change the way the system is developed. Large costs (even if they don't exist in the real world) can slow down the speed at which the system trades as in many forms of HFT, costs become a significant factor.
If you have already developed the system and are worried about costs significantly changing the profitability, then I think there is a reasonable chance that the system may not be robust enough. A system that has a known mathematical advantage but marginal profitability, can show superb results over short or even quite extended periods of time, but those profits are due to randomness. The system can also show severe losses even though the overall system is mathematically profitable, again due to the randomness of the order of the trades. You can check the probability of being profitable by Monte Carlo simulation, but that only shows you the odds that are in your favour. If you are unlucky and take a major hit as an institutional trader you can just start again using the odds to recover everything (presuming that you still have a job). If you are a private trader, you may have wiped out your capital base, in which case even though the odds are in your favour, you are out of the game (just like Russian Roulette). Of course some institutions even manage to blow up this advantage but that's another story.
So, even if your back testing shows that you have a profitable system and transaction costs become a factor, then you may be in for an unpleasant surprise when you trade in the real world. I won't go into this deeper as this is probably best in another thread.
this is what i live by - lay out the choices to correct this and a human mind can not come up with a logical solution. i am fully an advocate of machine learning, if not for that i would never have known much about advanced modeling.
bank's not retail firms or even clearing houses - will pay prime customers to provide liquidity. the prime customer, put's up as collateral the equivalent of his house to gain a bicycle so it is deserving that he be rewarded for that risk. that reward cost is passed along to those retail firms and clearing houses and ultimately their customers.
mark brown
ps i get sarcasm all the time, always the dog will bite the hand trying to set it's broke leg. doesn't change my compassion for the unenlightened.
I appreciate that you're trying to help out, but this is untrue at several levels.
(1) The liquidity rebates that you're talking about are well-specified and paid for by the exchanges, not the broker-dealer that works your orders. As a result, they are available only on some exchanges, and they are available to all retail customers at the places that they are, unless otherwise specified.
Prime bank customer - outside the exchanges. What your talking about does not apply.
mark brown
ps
pulled off google.. Definition of 'Interbank Market'
The interbank market for forex serves commercial turnover of currency investments as well as a large amount of speculative, short-term currency trading. According to data compiled in 2004 by the Bank for International Settlements, approximately 50% of all forex transactions are strictly interbank trades.
The financial system and trading of currencies among banks and financial institutions, excluding retail investors and smaller trading parties. While some interbank trading is performed by banks on behalf of large customers, most interbank trading takes place from the banks' own accounts.
the facts are i have no transaction cost or slippage - how i obtain that i have flirted with telling you that is why it will or will not make sense. you sound like you have experience in "formal" institutional trading businesses. you were possibly exposed to the informal way things work sometimes which do not follow the manual.
i think the industry as a whole can be summed up by the series 3 question which ask: why do the exchanges exist? for the benefit of the members. this after they teach you about how the markets were created to cure the injustices dealt to the poor farmer when he would bring his crop in every year the operators would ban together to pay the lowest price.
there are lines, and in between the lines, and then over the line which i do not condone. sorry to have strayed just trying to stimulate some out of the box thinking and discussion without giving away the farm.
build your model to take advantage of positive slippage -
back on topic - to reduce slippage and commission on a conventional trading model you could do as counter trend traders do and buy into a falling market to obtain a better price than expected, thus negating the cost of the transaction.
