@Beha, you are right on all counts.
However, the opportunity costs might be the hardest to determine since it will depend on what the future was or will be, and that is not accessible until after the fact. Will you wait for a ”I should have done....” when you had to make a decision: do you enter the trade or not? And then live with the consequences, whatever they may be.
What is the opportunity cost of what could turn out to be a losing trade? Would you not get again another ”I should have ....”? Putting you in total trade paralysis waiting for the outcome of all those “I should have...” to then again being confronted with: do you enter the trade or not?
No matter what you do, there will be real and tangible costs that can be seen on entering a trade (for instance: commissions). It is so direct that your broker will charge it immediately. We see much less on slippage since in a simulation we don't even see the bid and ask, or what the volume in the book was.
Not having access to that information, we are almost operating blind as to how much the real slippage will be. I see the broker report the commission as soon as you enter a trade. But, I have never seen them report: you had such and such in slippage per share for that trade.
I presented a case in another thread were 189 trades on TMF were spattered all over the trading day. 70 of those trades were for 20+ shares at a time. The rest (119 trades) were for 20 shares or less (due to the 2.5% rule). Some might not want to consider slippage, or commissions, but they do have an impact. And, it is higher than they think.
Trades were occurring about every two minutes, at whatever price there was. Sure, you will get an average price at the end of day. It could be close to the first trade taken, but then again, it might not. From what the trade report gave on that day, trades were executed from $ 23.33 to
$ 24.00 per share. This is more than a penny per share of slippage, the executed range was $ 0.67.
Nonetheless, we need to design trading strategies that will survive these more or less hidden costs. And it is not by hiding them that we will design better systems. It is by designing them even under these adverse trading conditions.
Not having a realistic frictional cost model, as a minimum, should be considered detrimental to anyone's trading strategy since what would be presented would be fluffed and puffed to look much better than it really is.
The equation for a fund is: F(t) = (1+L)∙F(0)∙(1 + r_m + α - fc% - lc% - d%)^t. And the alpha extracted should be enough to cover all frictional costs: α > |fc%| + |lc%| + |d%|. Where fc% is for commissions and slippage. And the alpha should be even greater in order to justify the added work.
It is why, in my strategy designs, I prefer to use the default IB settings. This includes the current Quantopian slippage setting and the minimum cost per trade. A trading strategy should at least cover those costs.
I have a prejudice against trading strategies that consider frictional costs as a major portion of their potential profits. All it tells me is that their strategy is so weak that it can barely exceed its friction costs. And since frictional costs, as a percentage, are low, it can only mean the overall return (CAGR) is low as well. There is a cost to trading, and the more you trade, the more it will cost.
If α < |fc%| + |lc%| + |d%|, then the generated alpha would not be enough to cover expenses or even beat the averages.
Maybe it is another way of saying there is no free lunch, or maybe that your broker or somebody else wants your lunch. They will just take it, without even saying a word since you are freely giving it away.