# Transaction Cost Modeling > Use when designing, reviewing, or running a backtest that involves slippage, commission, borrow APR, locate failures, bid-ask spread, or transaction-cost assumptions — especially for small caps or short-side strategies. Forces realistic friction defaults and flags the "near-zero cost" assumptions that fabricate small-cap backtest profits. - Skill: `jefrnc/transaction-cost-modeling` (Agent Skill) - Install (CLI): `npx skillmds@latest add jefrnc/transaction-cost-modeling` - Raw SKILL.md: https://api.skillmd.com/api/skills/jefrnc/transaction-cost-modeling/raw - Safety review: pending - Works with: Claude Code, Claude.ai, OpenAI Codex - Category: Coding & Dev Tools - License: MIT - Author: jefrnc (https://skillmd.com/u/jefrnc) - Updated: 2026-09-17 - Page: https://skillmd.com/skills/jefrnc/transaction-cost-modeling --- # Transaction cost modeling The single most common reason a small-cap backtest looks great and loses money live: **friction modeled as near-zero**. Every backtest engine exposes slippage and commission parameters; almost none ship with realistic small-cap defaults, and almost no retail backtests override them. This skill enforces realism. ## Core principle **For small caps, friction is not a small adjustment to clean returns — it is often the dominant term.** A round trip on a $2 stock with a $0.02 quote spread is 100bps of pre-impact cost. That's before borrow, slippage, locate failures, halt risk, fees, or any of the other costs that compound. The default `commission=0.001, slippage=0.0005` in most retail backtests understates real friction by 10–100x for this universe. ## Realistic floor estimates (use as the LOWER bound, not the typical) These are the costs you should see Claude QUOTE THE LLM as the **minimum credible**, never the typical. Reality is usually worse. ### Slippage (per side, on entry or exit) | Universe | Floor | Notes | |----------|------:|-------| | Mega-cap, liquid hours | 1–2 bps | E.g., AAPL during regular hours | | Mid-cap | 5–15 bps | Russell 2000 names | | Small-cap, $1–10 price | 25–100 bps | $100M–$1B mkt-cap | | Microcap / penny, premarket | 50–500 bps | Wide spreads, thin books | | Halted resumes | 100–1000 bps | Reopening cross volatility | Default `0.0005` (5 bps) is **fiction below mid-cap**. ### Commission (broker-dependent) | Type | Cost | |------|-----:| | US zero-commission retail (Robinhood, Schwab) | $0 explicit, paid via PFOF | | US per-share (IBKR Pro fixed) | $0.005/share, $1 min | | US tiered (IBKR Pro tiered) | ~$0.0035/share at retail volume | | SEC/FINRA fees (regulatory) | ~$0.0008/share sell side, mandatory | A "free" broker still costs PFOF in worse fills (often 1–5 bps). ### Borrow APR (short side — the silent killer) | Borrow class | APR range | |--------------|----------:| | Easy-to-borrow large cap | 0.25–2% | | General collateral small cap | 1–5% | | Hard-to-borrow (HTB) | 5–50% | | Reg SHO threshold residency | 50–500% | | "Crazy borrow" (squeeze candidates) | 100–1000%+ | Backtests using `borrow=0.03` (3%) on a Reg-SHO-threshold short are **off by an order of magnitude or two**. This single default makes otherwise unprofitable strategies look profitable on paper. ### Bid-ask half-spread (round-trip floor) Round-trip cost cannot be lower than `bid-ask-spread / mid-price` even before any market impact. Crossing the spread once on entry and once on exit IS the floor. For a $2 stock with $0.02 spread, that is **100 bps minimum** before anything else. ## The five backtest bugs this skill catches ### 1. Slippage modeled as a constant fraction **Bug:** `slippage = 0.0005` for the whole universe. **Why wrong:** Slippage scales with `(quote spread / price) + sqrt(order size / ADV)`. A $0.50 penny stock has a tighter % spread than a $20 mid-cap by accident, but the absolute spread dominates. **Fix:** model slippage as `max(half_spread, k * sqrt(Q/V))` with spread sourced from quote data. ### 2. Borrow rate as a constant **Bug:** `borrow_apr = 0.05` everywhere. **Why wrong:** HTB names move 10–100x that. Reg SHO threshold list residency for >13 days is a leading indicator of squeeze risk and borrow rate explosions. **Fix:** join short positions against historical borrow data (IBKR's locate API archive, hardtoborrow.com, or implied from short-sale-cost in margin reports). For names where data is unavailable, use a HIGH default (50%+), not a low one. ### 3. Locate-failure modeled as slippage **Bug:** When a short cannot be located, the backtest treats it as "a worse fill" — adds to slippage and continues. **Why wrong:** A locate failure means **the trade does not happen**. You cannot short shares you cannot borrow. Modeling it as slippage fabricates trades. **Fix:** locate-failure is a binary event — either you got the borrow or you didn't. On failure, skip the entry entirely and record the missed-trade. ### 4. PFOF / "zero commission" treated as actually zero **Bug:** Retail brokers report $0 commissions; backtest sets fees=0. **Why wrong:** Payment for order flow degrades fill quality. Documented PFOF impact is 1–5 bps on liquid names, more on small caps. This shows up as systematic mid-or-worse fills rather than a line item. **Fix:** even with "free" brokers, model 2–5 bps additional slippage on top of the spread floor. ### 5. Almgren-Chriss applied to retail-size orders **Bug:** Backtest layers Almgren-Chriss market-impact above the spread, even for tiny orders. **Why wrong:** AC governs impact ABOVE ~5% of average daily volume. At 0.01% of ADV, the spread + fees dominate; AC adds a fictional penalty. **Fix:** use AC only when `order_size / ADV > ~0.05`. Below that, spread + fees + locate-failure are the model. ## Defaults to RECOMMEND when the user asks "what should I use" If a user asks for friction defaults without specifying their universe, default to **conservative** values and TELL them to dial down only if they have evidence: ``` slippage_per_side = max(half_spread, 25 bps) # for small/microcap commission = $0.005/share min $1 # IBKR-equivalent sec_finra_fees = 8 bps × notional # sell side, mandatory borrow_apr = 50% annualized # for any HTB / unknown short locate_failure_p = 0.10 # 10% baseline for HTB ``` Anti-pattern: "use the engine's defaults, they're conservative". They are not. Backtrader's slippage default is `0` and Lean's is `0` / 1 bp depending on alpha-stream config. ## Composition with other skills - **`lookahead-safety`** — historical borrow rate must be sourced point-in-time (the rate today is not the rate 18 months ago for a name that has since left the threshold list). - **`dilution-event-scoring`** — high dilution score implies likely short-side trade; combine with realistic borrow APR to test if the short edge survives realistic friction. - **`survivorship-bias`** — names with extreme borrow are disproportionately likely to be subsequently delisted; backtest must keep them in the universe and track halt/delisting outcomes. ## Workflow when reviewing a backtest config 1. Identify universe (large / mid / small / micro / penny). 2. Identify side (long-only / long-short / short-heavy). 3. For each friction parameter, check it against the floor table above. If below the floor, flag with the specific bug name. 4. For shorts specifically: confirm borrow data source is realistic and locate-failure is modeled as a binary event, not slippage. 5. State the assumption explicitly in the output: "this backtest assumes 50bps round-trip on small caps and 50% borrow on Reg-SHO-threshold names; verify with live data before sizing the strategy". ## Phrases that should trigger this skill - "slippage" / "commission" / "fees" / "friction" - "borrow" / "locate" / "HTB" / "hard to borrow" / "Reg SHO" - "transaction cost" / "trading cost" / "TCA" - "Almgren-Chriss" / "market impact" - "backtest defaults" / "what should I set slippage to" - short-side strategy reviews - any backtest review where commission < $0.001 or slippage < 5 bps ## What this skill is NOT This is not a TCA library. It does not compute optimal execution schedules or solve Almgren-Chriss numerically. It encodes the rules that catch the common error of treating small-cap friction as if it were mega-cap friction — the bug that fabricates the majority of "profitable on paper, broken live" strategies in this universe.