DARWIN slippage, explained

5 January 2015
Juan Colon

Investopedia defines slippage as the difference between the expected price of a trade, and the price at which the trade is actually placed.

DARWIN slippage owes to DARWIN investors’ trades generally not clearing at their providers’ level, which makes DARWIN investor performance different from DARWIN performance.

By how much is transparently tracked and disclosed on the interface.

Slippage, tracked for your DARWIN portfolio

Slippage, tracked for your DARWIN portfolio

Why?

DARWINs track strategies traded with the Darwinex broker. Whenever a DARWIN provider strategy triggers a trade confirmation, we process a trade on behalf of investors in its DARWIN.

DARWIN Slippage happens because of:

  1. Latency: time lapses between provider and investor trade
  2. Liquidity: market liquidity is finite
  3. Tracking: a DARWIN investors cumulatively buys into any trades open before he bought into the DARWIN

Further,  currency risk introduces slippage when DARWIN provider and investor account base currencies differ.

Latency

DARWIN replication works as follows:

  1. Provider strategy: trades normally clear in 4 ms, in and out of the DMA order-book.
  2. Darwinex receives DMA trade confirmation
  3. Darwinex triggers investor trade request
  4. Investor trade request is fully cleared

Inevitably, time lapses (sub-second) from 1. through to 4. Markets moving all the time,  yields a difference between DARWIN provider and investor price. For typical DARWIN providers (no high frequency trading, trades taken several minutes at a time) this difference is random: sometimes providers “win” and sometimes “investors” win more.

Liquidity

Anyone entering the order-book for an asset inevitably moves the market price against him… unless their buy/sell order is matched by opposite demand providing “liquidity” or “market depth”.  You may read more on order-matching here.

Investor trades with significant size relative to prevailing market depth move the price against them, which results in systematic price differences against the DARWIN investors. The DARWIN Investor Appeal rating for scalability tracks the likelihood and impact on their performance. Watch out for strategies with low scalability scores: their effective performance must be considered in the larger context of slippage and may lag the DARWINs performance by non-negligible amounts.

http://youtu.be/Q4xIjt8Kmyg

Tracking

Tracking slippage happens whenever you buy into DARWINs with live trades.

Whenever the DARWIN provider opened the trade you’re now tracking, he paid the commissions that “bought” him performance over the full lifetime of the trade. Since you’re buying “mid-trade”, some of that performance may have accrued, perhaps over months. Think of it this way: you’re paying full commission, but not getting your full share of  performance.

The impact will be higher, the better the DARWIN: imagine a trader so accurate that his trades NEVER enter the red, and only accrue incremental P&L. In this situation, tracking will hit you worst.

Currency risk

DARWIN performance is calculated in terms of the provider’s base currency (in fact, it tracks performance on the provider’s equity).

Whenever this is different from your investor base currency, you’re exposed to currency risk for the P&L of each DARWIN trade.

This is because your DARWIN trade’s P&L, as an investor with currency risk, is driven by two sources:

  1. The trade’s performance: which affects the DARWIN provider as it affects you
  2. The evolution of your base currency vs. the DARWIN provider’s base currency for the duration of every trade, which affects you, but does NOT affect the DARWIN provider

Given the (short) average duration of DARWIN trade, the fact that we only admit EUR, GBP and USD base currencies (the most stable, generally speaking) and the fact that there’s plenty of trades for this effect to even out over time, the impact of currency risk is non-directional (i.e. sometimes you’ll win, and sometimes you’ll lose).

Relative impact

Relatively speaking, tracking, latency and currency slippage average out over time: investor performance will NEVER exactly match the DARWIN notional performance, but the error will be very small and fade out over time.

Liquidity slippage, on the other hand, does not, and will be the more severe:

  1. The less scalable the DARWIN
  2. The larger the size of investor funds tracking a given DARWIN, relative to the provider’s account size

Eventually, slippage for popular DARWINs WILL become so bad that investor performance will not compensate for the risk.

At this point, the strategy will have been scaled to the outmost, and the DARWIN  fulfilled its mission.