Staying one step ahead of forex slippage

Slippage—a blessing or a curse?

Have you ever experienced entering a trade at a certain price but ended up happening at a different rate? Well, this phenomenon is what we call “slippage” in forex trading. The nature of slippage intertwines potential gains and setbacks, making it an intriguing subject for traders and investors alike. Understanding how forex slippage works help traders decrease negative slippage and potentially increase positive slippage, giving them more control over their trades.

What is slippage?

Slippage is when a trade order is executed at a price that deviates from the one initially requested. We can observe this phenomenon happening more frequently during periods of high market volatility, where unexpected shifts in trends typically happen. It also arises when a large order is placed without sufficient volume to accommodate the bid/ask spread at the desired price. As long as the actual execution price is different from the intended price, be it higher or lower, we still refer to this situation as slippage.

What causes slippage?

Generally, slippage happens when there is low market liquidity or high volatility. In markets with low liquidity, there is a scarcity of traders willing to assume the opposing position in a trade. Hence, there is a longer period between placing the order and the order being executed after a buyer or seller has been found. Due to this delay, the price may change which then causes slippage. In volatile times like economic data releases and breaking news events, prices may fluctuate rapidly, even within the brief time required to execute an order.

Keep in mind that less popular currency pairs such as USD/MXN and USD/HKD are more prone to slippage in comparison to major currency pairs where they are more liquid and experience less volatility. 

What are some examples of slippage? 

Let’s picture this: You are attempting to purchase EUR/USD currency pair where it currently sits at 1.2060 on your trading platform. So 1.2060 is the price that you intend for your buy order to be executed at. From the communication transfer to data processing, there will be three possible outcomes when the order completes. 

Outcome #1: No slippage

The order is placed and the best available buy price being offered is at 1.2060, the order is then filled at 1.2060. There is no slippage here as the order was executed exactly at the price you requested.

Outcome #2: Positive slippage

The order is placed and then the best available buy price being offered suddenly moves to 1.2055, the order is then filled at 1.2055. This is referred to as positive slippage as the order is filled at a price that is 5 pips below your requested price.

Outcome #3: Negative slippage

The order is placed and the best available buy price being offered suddenly moves to 1.2065, the order is then filled at this price of 1.2065. This is referred to as negative slippage as the order is filled at a price that is 5 pips above your requested price.

How can I avoid slippage?

Trading in markets with low volatility and high liquidity can help decrease slippage. Prices will be less prone to move quickly in low volatile markets and high liquidity indicates ample buyers and sellers present, creating a favorable trading environment. Trading during peak activity hours may also limit your exposure to slippage as you target the high liquidity window.

Another effective method to minimize slippage is to refrain from trading around major economic events. Typically, price fluctuations tend to escalate during such events, making it more favorable to wait until after the news release to enter a trading position. Exercising patience in this scenario can potentially yield rewarding outcomes.

Now, we have to mention guaranteed stops and limit orders when on the topic of slippage. With guaranteed stops, they offer protection against slippage by ensuring your trade is closed at the exact level you select. Thus, they are considered the most reliable approach to minimize the risk of the market moving unfavorably. Limits are essential in reducing slippage while starting a trade or aiming for profitable trades by setting specific price thresholds, granting traders greater control and protection against unfavorable price changes.

Final thoughts

Slippage is a part and parcel of forex, a natural aspect which is unavoidable during trading. It’s not always a bad thing, and now that we understand its occurrence, we can proactively manage and lessen its impact. By anticipating it and strategizing accordingly, we don’t have to let slippage negatively affect our trading outcomes, but instead navigate the market with greater control and adaptability.

Hits: 124