What is Slippage?
Like most other markets, the Forex market is a fast-moving one. Prices can change from minute to minute, second to second. That may bring pressure for traders, but if to think, it is a good thing in fact. Since, if prices stayed stable and never changed, profits will never be made. One especially irritating part of changes for traders, because of this truth, is slippage.
In financial trading, slippage is a term that refers to the difference between the trade’s expected price and the actual price at which the trade is executed. It may cause the traders to enter or exit a trade at a price that is either lower or higher than their expected price. This can happen during high periods of volatility as well as periods in which orders cannot be matched at the trader’s desired prices. The reason for it is that in the markets buy orders must be matched with sell orders of equal price and size. Whenever there is an imbalance of buyers, sellers, trade volumes, etc., prices will be adjusted to the next available price in the market.
Example of Slippage:
Understanding how forex slippage occurs can allow traders to minimize the negative effect slippage has on their positions. In this article, we will be showing different examples of slippage, explain why slippage happens and how to avoid it.
Three Different Scenarios of Slippage:
Scenario 1: No Slippage
A trader places a market order and the best available buy price is being offered is 1.2550 (exactly at a price level what a trader requests) the order is then filled at a price of 1.2550.
Scenario 2: Positive Slippage
A trader places an order and the best available buy price is being offered suddenly changes to 1.2540 (10 pips below the requested price), the order is then filled at this better price of 1.2540.
Scenario 3: Negative Slippage
A trader places an order and the best available buy price is being offered suddenly changes to 1.2560 (10 pips above the requested price), the order is then filled at this price of 1.2560
Why and How Slippage Happens?
There are a few reasons due to which slippage happens. The first reason is Liquidity. In this case, several options are possible. For instance, if the trader requests larger order and there is less liquidity left in the market, the order is split into parts and sent to several liquidity providers. As a result, the trader receives a weighted average price, which may be less or more than the requested price. In such a situation, the order slips partially. Furthermore, the liquidity provider might send a refusal to execute the order. In this case, there may be a delay as the order will be sent to another liquidity provider. As time passes, the market offer at the price the trader expected could be gone.
Often during news releases, volatile market conditions, there is a problem with liquidity and orders are slipping a lot. Many banks and institutions that act as liquidity providers, leave the market to protect themselves from price spikes and potential losses. At the same time, spreads widen as brokers want to protect themselves from possible losses. That is why traders have problems during major news releases. The spreads are large, the slippage is strong and it becomes much more difficult profit in such conditions.
Lack of liquidity also occurs when trading exotic currency pairs. For example, with Turkish lira, African rand, Russian rubles, etc. The reason for it can be that those currencies are not among the most traded ones, so the volumes tend to be low. Because of the low volumes, exotic currencies tend to lack liquidity and market depth.
Another reason for slippage can be named as- Technical Problems. These include network delays between the trader’s trading terminal and the server, issues with the liquidity providers, as well as a weak Internet.
How to Deal with Slippage?
It is important to note that a trader cannot completely avoid slippages at all times. It can be considered as the cost that a trader pays in order to place the trades. Rather, by controlling it can be minimized, and at some times, fully avoided.
The Below we will highlight some factors that may be helpful in this issue.
· Strong and stable internet: Not lagging, strong, and stable internet is vital for successful trading. It is believed that a wired connection is much better and stable than Wi-Fi. In addition, while working in the terminal, always try to disable the programs that use the network.
· Use of limit orders: All limit orders are considered to be immune to slippage. By using a limit order while opening a position you make sure that a limit order can be only filled when the price reaches the requested level.
· Trade during times when the volume in the market is high: There are 3 major trading sessions, to be specific, the London session, New York session, and Asian session. More traders are active during these times. Thus, as more traders are active during these sessions, it brings high liquidity to the market, making trades less sensitive to slippage. In addition, there is a period in the market when the New York and London hours overlap, and liquidity in the market is at a peak in such conditions.
· Avoid trading during news releases: Many times problems with liquidity arise at the release of different news. This includes such major events as meetings of Fed, or BoE, when it is not clear what will be announced after the meeting, and so on. Therefore, try not to trade some time before and after the news is released, this way eliminating the liquidity problem.
· Choose a reliable broker: A trustworthy provider, such as FTD Limited, will execute the orders at the better and best available prices. Additionally, it should have low slippage rates and fast execution speed that will help you in limiting the size of the slippage.
Slippage, along with swap, and commission, is an important part of trading. Although it’s difficult to fully get rid of negative slippage, its effect can be minimized. In dynamic trading environments where prices change rapidly over a wide range, it’s especially a big problem traders face. There are, however, methods, as we have mentioned above, available that can help to minimize the problem posed by slippage. To avoid unnecessary losses in trading, traders should take these into consideration.
In any case, for both negative and positive slippage occurrences, it’s essential to find a trustworthy brokerage such as FTD Limited, that will execute the orders at the best market price available.
We hope it was made clear to you what is slippage and how to minimize its effect on your orders. Please feel free to reach out for further information.
Wishing our readers a good and profitable week!