Transaction Costs and Slippage Models [/trænˈzækʃən ˈkɔsts ənd sˈlɪpɪʤ ˈmɑdəlz/] n - Transaction costs are the gap between paper return and realized return. They are not commissions alone; they take in the bid-ask spread, market impact, slippage, borrow fees, financing, and taxes. A strategy that ignores any of these is incomplete.

Explicit costs are easily measured. Commissions and fees are known before the trade, scale linearly with volume, and are usually small for large institutional desks; they matter most for high-turnover strategies.

Implicit costs are where the money is lost. The spread is the difference between the price at which you can buy and the price at which you can sell. Market impact is the price movement caused by your own order. Slippage is the difference between the intended fill price and the actual one, oft because the market moved between signal generation and execution.

A simple slippage model adds a fixed fraction to each trade:

$$\text{fill price}=\text{signal price}\times (1+s\cdot \text{sign})$$

where $s$ is the slippage rate and sign the direction of the trade. A more realistic model makes slippage depend on volatility, volume, order size, and time of day.

Market impact models usually begin with the square-root law:

$$I=c\sigma {\left(\frac{Q}{V}\right)}^{1/2}$$

where $\sigma$ is volatility, $Q$ order size, $V$ daily volume, and $c$ a constant calibrated to execution data. Market Impact and Optimal Execution shows how this feeds into order scheduling.

Opportunity cost is the least visible cost of all: the return foregone when an order goes unfilled or is filled with delay. A limit order that never executes misses the move; a market order that executes at once pays spread and impact. Trading is the management of these trade-offs.

The honest backtest assumes costs conservatively and validates them live. A model that still works under realistic costs is a better candidate than one with perfect fills that barely works at all.