A strategy that looks profitable on a chart, or even in a simple backtest, can turn unprofitable once every real trading cost is subtracted from every trade. This gap between gross and net performance is where many otherwise sound ideas quietly fail, and it deserves the same rigor as the entry and exit logic itself.
The Four Cost Components
- ▸Spread — the bid-ask gap paid on every entry and often on every exit.
- ▸Commission — a fixed fee per lot or per trade, common on raw-spread accounts.
- ▸Slippage — the gap between expected and actual fill price, especially around volatility.
- ▸Swap — the overnight financing charge or credit for positions held past rollover.
Gross Expectancy vs Net Expectancy
Net Expectancy = Gross Expectancy − (Spread + Commission + Avg Slippage + Swap, per trade)A strategy that shows a gross expectancy of, say, an illustrative 3 points per trade before costs can easily fall to near zero or negative once realistic round-trip costs of 2-3 illustrative points are subtracted, particularly for high-frequency approaches that generate many trades per day. The higher the trade frequency, the more precisely costs must be modeled.
Why Backtests Often Overstate Performance
Many amateur backtests use the mid-price or ignore spread entirely, assume zero slippage, and skip commission and swap altogether. This produces a curve that looks smooth and profitable but bears little resemblance to what would actually happen in a live account, especially for short-term strategies where costs represent a larger share of the expected move.
| Trade frequency | Cost sensitivity | Modeling requirement |
|---|---|---|
| Position trading (days-weeks) | Low | Basic spread and swap estimate usually sufficient |
| Swing trading (hours-days) | Moderate | Include realistic spread and occasional slippage |
| Scalping / high-frequency (seconds-minutes) | Very high | Precise per-trade cost model, including slippage distribution |
Any backtest or strategy evaluation that does not explicitly include spread, commission, slippage, and swap assumptions should be treated as a rough sketch, not evidence of real profitability.
Practical Steps to Protect Edge from Decay
- 1.Always model realistic round-trip costs in any backtest or forward test before trusting the results.
- 2.Track actual realized costs from a live or demo account and compare them to the model's assumptions.
- 3.Favor strategies whose average target size comfortably exceeds total round-trip cost by a wide margin.
- 4.Re-evaluate cost assumptions periodically, since spreads and swap rates change with market conditions.