Importance Of Market Orders vs Limit Orders, In Backtesting "Model Performance Report Generation", Of A Quant Trading Model.

When backtesting a model using trading rules, it is important to consider the difference between market orders and limit orders, and how these order types can affect the accuracy of the backtest results.

A market order is an order to buy or sell a security at the current market price. When a market order is submitted, it is executed immediately at the best available price. In a backtest, market orders are typically assumed to be filled at the closing price of the day on which the order was generated.

A limit order is an order to buy or sell a security at a specific price or better. When a limit order is submitted, it is only executed if the market price reaches the specified price or better. In a backtest, limit orders are typically assumed to be filled at the specified limit price, or not filled at all if the market price does not reach the limit price.

The choice between market orders and limit orders can have a significant impact on the accuracy of backtest results, as different order types can result in different fill prices and transaction costs. Here are some factors to consider when choosing between market orders and limit orders in a backtest:

1. Realism: Market orders are more realistic than limit orders, as they reflect the fact that in a real trading environment, orders are executed at the best available price. However, limit orders may be more appropriate for backtesting certain strategies, such as those that rely on specific price levels or that require more precise control over fill prices.

2. Transaction costs: Market orders typically result in higher transaction costs than limit orders, as market orders are executed immediately at the best available price, which may include a wider bid-ask spread. In a backtest, it is important to account for transaction costs, as they can significantly affect the profitability of a trading strategy.

3. Liquidity: Market orders may be more appropriate for securities with high liquidity, as there is typically enough volume to ensure that market orders are executed at or near the current market price. For less liquid securities, limit orders may be more appropriate, as they can help to prevent the trader from overpaying or underselling due to poor liquidity.

4. Slippage: Slippage refers to the difference between the expected fill price of an order and the actual fill price. In a backtest, it is important to account for slippage, as it can significantly affect the accuracy of the backtest results. Slippage can be higher for market orders, as they are executed immediately at the best available price, which may be different from the expected price.

When backtesting a trading strategy, it is important to carefully consider the choice between market orders and limit orders, and to use a consistent order type throughout the backtest. This will help to ensure that the backtest results are accurate and reflective of the expected performance of the trading strategy in a real trading environment.