Slippage and Expertise, 11/28/10
Slippage and ExpertiseThe lower a trader's skill level, the bigger the per-trade return necessary to make up for lack of expertise (realized as slippage) in entry, exit and trade selection. The relatively un-skilled trader needs larger returns to overcome 'Exerptise Slippage'.
As pure trading skill increases, smaller returns per trade are necessary to make up for deficits in skill level and more trade opportunities become available. (When I ran this by a friend of mine he immediately said, "Allows diversification." Which, of course, is brilliant - immediately goes to adaptability, sustainability and longevity in light of ever-changing cycles.)
Algorithm deployment follows similar logic: algorithms with relatively unsophisticated entry and exit techniques, i.e., lower trading skills, should select higher return trades to make up for the slippage they are giving away to more sophisticated traders.