What is slippage in trading?
Slippage, which refers to any scenario in which a trader receives a different deal execution price than anticipated, is a common occurrence in trading, and you should be aware of its consequences on your trading execution process and results, as well as the ways in which you can reduce its impact.
Explain it like I’m 5
If you’ve ever requested to make a trade with your broker at what you felt was an acceptable price, only to discover that the price has now changed while the trade was being executed, you’ve just experienced slippage.
Slippage can occur in Forex, Bonds, Equities, Commodities, and any other markets, whether you’re buying or selling, but it’s more likely to happen in fast-paced environments where there are many price fluctuations.
A simple example of slippage on the Forex market
Let’s say, for example, you’re hoping to lock in a Forex trade. You go to your broker to place a buy order for GBP/USD at 1.2314.
During the time it takes to execute the trade, you could experience no slippage at all and the trade is made at the requested price of 1.2314.
Positive slippage could occur – maybe your trade is made at the lower rate of 1.2310, which means that you can potentially earn more if prices rise.
Negative slippage could also occur, which means that you can potentially earn less if prices rise. In our example, you end up having to buy the currency pair at the higher rate of 1.2318, for example.
All of these scenarios are possible, and you’d better have a plan in place to reduce the risk of slippage.
Is slippage always negative for your trading?
As in the example above, slippage doesn’t always lead to a loss. It could be a good thing, a bad thing, or completely inconsequential.
Positive slippage will happen when your order is executed at a better price, while negative slippage will occur when your trade is executed at a worse price.
Generally, it’s considered a bit of an annoying but inevitable cost of doing business to most traders, because there is an inherent level of uncertainty involved. There are, however, ways to be prepared for it and strategies that you can put into place to limit the possibility of losing out.
This should be part of your trading plan for overall risk management.
Why does slippage happen?
Some markets are more prone to slippage than others, and there are various scenarios that cause it to happen more frequently.
Placing a trade is not an instantaneous process. Even during microsecond transactions with online programs, anything can happen to the price of the asset you’re attempting to buy or sell. You’ll find slippage occurs regularly in highly volatile markets where there are quick fluctuations in prices.
If you’re interested in the often fast-paced market of Forex, for example, news or highly anticipated events can cause large fluctuations in a short timeframe. Changes such as new monetary or company policy and releases of important economic and company data can have a huge impact on volatility, and it’s important to keep an eye on these things as you go.
Another reason for slippage is that there is not enough liquidity in the markets you’re trading, which means that any position can have a significant impact on the price. Not to mention that trading in illiquid markets is more expensive and you might not be able to find counterparts to buy or sell the selected financial asset.
Is it possible to reduce slippage?
As we mentioned above, you probably can’t completely avoid slippage, it’s an accepted cost of trading. If you’re keen to reduce your risk of experiencing it, though, there are a few things you can do. Just be wary that there are pros and cons to employing certain measures. You may be managing your risk, but you might also miss opportunities as a result.
Use limit orders instead of market orders
A market order is a type of buying/selling instruction from an investor to a broker. It’s used to purchase/sell all kinds of assets, but at whatever the best price is available in the market at that time, so these can be prone to slippage.
A limit order will allow you to enter the market at – or better than – your intended price, or not at all, which would avoid the possibility of negative slippage. If you’re using a limit order though, there is less flexibility than a market order.
If the price of an asset is pretty close to your ideal purchase price but not quite there, the order will be declined, and you might miss out on a good opportunity by a small margin, depending on your broker’s policies.
You’ll also miss out on a trade being completed with a limit order if there isn’t enough volume there to make the trade.
Consider guaranteed stop-loss
By using guaranteed stop-loss orders, you can be sure that your protective orders will be executed at the requested price, which will eliminate slippage from your trading if the markets go against you.
Trade more liquid markets and avoid highly volatile moments
The time and place of your trading matter if you’re trying to reduce slippage too. Trading in markets with high liquidity and you’ll have plenty of buyers/sellers to accommodate the opposite side of your trades.
Liquidity and volatility can be affected by the time of day you choose to trade in certain markets too. Forex may be available to be traded on a 24-hour basis for example, but the greatest amount of activity happens when two trading sessions overlap, like the London and New York sessions.
If you prefer to trade the stock market, usually the highest volume is during the opening/closing, as well as when key statistics are about to be published.
Keep an eye out for major news
As we mentioned above, it’s a good idea to keep up to date with current events and upcoming monetary policy changes relative to your chosen investments to avoid surprises, as this is when the largest amount of slippage happens, due to higher volatility. Avoid trading immediately before and after these events and you’ll minimize the potential risks of slippage.
If you trade when the market is closed, or outside of normal hours (like the weekend or during the night, for example) you may also run the risk of major news being released during that closure, and then experiencing high volatility and slippage when the market reopens.
Be sure you’re using a broker with a fast and reliable trade execution policy
To avoid slippage as much as you can, it’s also important to know about your broker’s execution policy. ActivTrades, for instance, has a state-of-the-art trading infrastructure that provides an optimal trading experience to its users, with an average execution below 4 milliseconds and more than 93.60% of orders executed at the requested price.
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