Model Risk

Fixed Spread, Variable Spread, Commission and Swap

Depending upon the account and broker that is used, they may have different Bid/Ask spreads.   These spreads may be fixed or change throughout the day.   Most brokers charge a swap rate, which represents the interest/cost of borrowing for the trade.   In addition to this, some accounts charge a Commission.  This means that it is quite possible for an algorithm to behave differently if I run it against the same currency pair in different brokers or in different account types.

In addition to this, it is important to realise that there are limitations to what the Strategy tester being used can simulate.   For example, the following image shows the strategy tester from MetaTrader 4.   It is clear that the Strategy Tester uses a fixed spread and does not model the variations in spread that I may observe when running it against a live Broker account.

Img 1.1 – Spread is fixed at 21 points.

I also believe that it is sensible to assume that changes in the Stop Level and Freeze Level could also impact the model when it is run against a live trading account.