Slippage is an occurrence in the financial markets you may or may not have heard of. It simply means; not getting into a trade at your desired entry point or price. Whenever you want to buy or sell an instrument, say a currency pair, you would be filled at the best available price.
Sometimes your intended price is not the best available price so your trade would be entered at an unintended price; and that is when slippage occurs. This is something many traders despise but it is not always a bad thing as you would notice later on in this lesson.
Types of slippage.
Let us say you wanted to buy EURUSD at a price of 1.1835; but then you get filled at 1.1851, you have experienced slippage and that is a 16 pip difference from your entry point. It can occur with a sell position as well and I guess you can make an inverse case for a sell too.
The instance above is why it gets such a bad rap; perhaps this may be the most common type. In that instance that 16 pip difference could have been realized as profits but because of slippage you are short of some profit. That is negative slippage. This is when you get a price that is worse than your intended entry point.
There is positive slippage as well. It is when you get a better price than your intended entry point. For instance, instead of buying EURUSD at a price of 1.1835; you get filled at 1.1824. That is an 11 pip difference and you get to experience this slippage as an early profit since the market filled you in at a better price.
If you wanted to buy EURUSD at 1.1835 and got in at that same price, that would be termed as no slippage. This is the most common occurrence for many traders and that is exactly how it should be. Liquidity providers or banks would however do their best to always fill trades in at the best available price.
Why slippage occurs.
For every buyer in the market, there must be a seller to match the price and size of the trade; for an exchange to occur. If you want to buy 10 lots of EURUSD at 1.1835, then there should be another trader willing to sell 10 lots of EURUSD at that same price to match your order. If orders are matched perfectly, there would be no slippage.
An imbalance of buyers and sellers at desired prices is what causes both positive and negative slippage. As a buyer, if the best available price is higher, you would experience negative slippage and if the best available price is lower, you would experience positive slippage.
Even though very uncommon, slippage in forex may occur on stop loss levels and take profit levels as well. Technically, those levels are part of buy and sell orders. This is one of the reasons why you cannot avoid risk wholly in trading.
When slippage is likely to occur.
In periods of high volatility, you are most susceptible to this concept. During volatile periods, there may be a bit of uncertainty and panic in the market which could be causing the rapid change of prices in the market.
Volatile periods may arise from some surprising results of an economic news announcement or some unpredictable events like natural disasters and the likes. Learn how to position yourself well in times like this here.
Also, when there are not many market participants and you try to trade, your chances of getting different prices are very high. In the first hours of market open and getting to the close of a trading day; many of the market participants may have pulled out.
This causes low liquidity and if you trade at such times, getting someone to match your order could be a problem. In those times your order may not go through, you may experience slippage or you would pay a higher than usual spread. Get your grips on when to trade and when not to trade in this lesson.
Getting large orders in the market could also cause this occurrence. However the topic of large orders is not much of a concern to retail traders; since a single retail trader’s order cannot shake the market. This is the headache of institutional traders.
Due to the fact that large orders in the market could cause abnormal slippage; the big players enter trades gradually at relatively different levels. This is one of the reasons why stop hunting is an ethical practice in the trading industry.
How to prevent this occurrence.
Slippage is an occurrence that affects market orders mostly. One way to avoid experiencing this occurrence is by strictly using stop and limit orders to enter trades. Market orders fill your trades instantly whereas stop and limit is price dependent.
The worst that could happen when you use stop and limit orders is that; the market would not reach you desired prices so your trades would not be filled. This means, good moves may take off without you sometimes.
Volatility and liquidity are very crucial. Try to avoid trading in periods of high volatility or low liquidity as discussed in the session above. Low volatility and high liquidity is a good way to trade in sane market conditions; which will help you avoid slippage and high spreads altogether.
Some currency pairs are susceptible to slippage than others. The best currency pairs to trade in reference to this topic are the major currency pairs. The major currencies have many market participants so they get to enjoy highly liquid moments with little volatility.
EURUSD even though used in the instance above is one of those pairs on which slippage is very uncommon.
Exotic currency pairs have the unhealthy combination of low liquidity and high volatility and are therefore most susceptible to slippage. Coupled with that is the high spread you will pay for if you trade them. To avoid slippage, you may want to avoid these ones too.
Slippage is not an all-out negative occurrence in the market as demonstrated in this lesson; but it will only do you good to know how to position yourself well in the markets. As a matter of fact, slippage is very uncommon even if you try not to avoid it.