Slippage in forex trading defines the gap between the expected price and the actual price at which a certain trade is made. It is mostly observed in sensitive sectors where goods prices keep changing with the time within which the trader has ordered the product and the time he or she has received the product. This can lead to execution at a better or worse price than expected. Forex traders need to understand slippage and its impact on profitability, especially during volatile or illiquid market periods. This guide explores the causes of slippage in forex trading, the types of slippage, and how to avoid it.
Types of slippage
Positive Slippage in Forex Trading
Positive slippage is such a situation where a particular trade gets executed at an even better price than requested. This occurs when market conditions move in the trader’s favor after placing the order but before execution.
Example of Positive Slippage
The trader gains a better-than-expected entry by placing an order at 1.3000 but executing it at 1.2995 due to favorable market movement.
Positive Slippage Benefits
- Increased Profitability: A lower entry or higher exit will increase overall profit.
- Better Trade Execution: This means that the market moved in the trader’s favor before the order was finalized, hence giving an advantage.
Slippage is less common compared to its negative counterpart. The positive can add to the profit each time it happens, especially within volatile or high-speed markets.
Negative Slippage in Forex Trading
Negative slippage is when a trade goes through at an unfavorable price than requested. In such cases, market fluctuations between order placement and execution may result in higher costs or lower returns.
Example of Negative Slippage:
He would have placed his buying order at 1.3000, but due to unfavorable market conditions, if the order gets executed at 1.3005, he is buying at higher prices.
Benefits of Negative Slippage:
- Decreased Profitability: The trader gets reduced gains or increased losses because the trade was executed at a less favorable price.
- Increased trading costs: This can raise the overall cost of trading, especially when the occurrences of negative slippage are frequent.
Negative slippage is quite customary in volatile markets or during periods of low liquidity. Price action could be sudden and unpredictable during these times.
No Slippage in Forex Trading
No slippage occurs when a trade is executed at precisely the price requested by the trader. That means there isn’t any difference between the expected price and the actual execution price.
Example of No Slippage:
In such a case, if a trader places a buy order at 1.3000 and the trade gets executed at 1.3000, then there is no slippage, and the trader receives the exact price anticipated.
Benefits of No Slippage
- Optimal Execution: The trade is executed as planned, with no deviation from the requested price.
- Predictability: This helps traders maintain proper risk management and profit expectations since there are no surprises in the change in the trade execution price.
No slippage is ideal for traders relying on exact price levels for their strategies. Traders can reduce slippage by using limit orders and trading during high liquidity periods, though this is less effective in volatile or low liquidity markets.
Causes of slippage:
Change in the exchange rate
Because of increased demand or supply of a currency pair, the exchange rate may change at the very instant that you are processing an order. This happens during times of high volatility. The market price is now different from the price fixed therefore causing slippage.
Lack of liquidity
If the currency pair’s market is not liquid at the desired price, the market order will execute at the next available price level. Such an order can be executed through a market stop order or limit order.
For example, if you want to sell 100 units of USD/EUR at 2 but only 50 units are available at that price, the system will fill your order for 50 units at the specified price. The other 50 units will be traded at the following best available price.
Market Volatility
If the forex market currency pair is too volatile, then the possibility of slippage will be higher. This happens because fluctuating currency pair prices can lead to your order being executed at a different price than what you set with your broker. Big economic or global events can increase slippage in currency pair prices.
Price gaps
Slippage also occurs when a price gap occurs due to a big news announcement or due to the closing and opening markets showing significantly different price levels. A significant weekend gap can cause an order to execute at a different level than the set price.
Difference between buyers and sellers
Slippage is more likely to occur when the number of buyers and sellers of a particular currency pair is not symmetrical. The theory suggests that for every buyer offering a price for a lot size, there must be an equal number of sellers willing to match that price to execute the order. In a demand-supply gap, currency pair prices may deviate from their intended position, causing slippage.
Top tips to avoid slippage
Set a slippage tolerance level
Most forex platforms allow traders to set their slippage tolerance levels wherein they provide a percentage up to which they are ready to accept the price gap. Any price difference beyond the slippage tolerance level rejects the order altogether, and the order is not executed.
Place guaranteed stop-loss orders
Guaranteed stop-loss orders ensure that the trade is exited at the exact price you fix in case the market moves against your trade. This helps you protect your trade positions no matter how volatile the market is, and you do not lose more than your tolerance through slippage.
Shift to limit orders from market orders
You can also avoid slippage by shifting to limit orders instead of market orders. You can set limit orders to execute at your desired price or better when the currency pair reaches it. If the currency pair trades at a price worse than what you set, the limit order expires and is not executed.
Avoid trading around major economic announcements
Most slippage occurs when there is a positive or negative economic event ongoing. To avoid slippage, track global news events that might impact forex prices and avoid trading around those times. Traders can avoid slippage by steering clear of trades during periods of high volatility, such as pandemics or wars.
Trade the non-traditional hours
You can avoid slippage by trading in non-traditional hours as the market is the least volatile during these hours. Trading in the early or late hours of the day witnesses the least volatility as fewer buyers and sellers are trading the currency pairs at that time. This enables traders to execute market orders at their specified prices.
Trade when the market is highly liquid
Trading in a highly liquid market indicates that there are as many sellers as there are buyers. This reduces slippage and ensures orders are executed at the trader’s specified prices. When a currency pair trades with high volume, the slippage is less and order execution is more seamless.
Trade with high execution speed brokers
Choose a broker that maximizes execution speed to ensure instant order execution without delays. Order execution delays can cause slippage, where the fixed price diverges from the market price due to currency fluctuations. When a broker executes an order within seconds, there’s minimal time for currency pairs to fluctuate, resulting in little to no slippage.
Frequently Asked Questions
Is slippage always negative?
- No, slippage can be both positive (better price) or negative (worse price), though traders often experience negative slippage more frequently.
How can I reduce slippage in my trades?
- To minimize slippage, trade during high liquidity periods, place limit orders, and choose brokers that offer faster execution.
When to avoid slippage as a trader?
- Day or short-term traders: Day or short-term traders hold several forex positions in a single trading day to make gains from small price moves. As a day trader, avoid trading currency pairs during news events and global updates like earnings reports and employment summaries.
- Swing or medium-term traders: Swing or medium-term traders hold a forex position for a few weeks or months to make gains through a particular trend in the market. As a swing trader, avoid trading after major announcements, such as wars, pandemics, or significant economic pressures.
- Position or long-term traders: Position or long-term traders hold a forex position for at least one year or more to make gains from the overall market sentiment. As a position trader, avoid trading near financial year-ends and major announcements like national budgets, trade balances, and GDP reports.
