What is Slippage?
What is Slippage?
In financial trading, slippage is a term that refers to the difference between a trade’s expected price and the actual price at which the trade is executed. It is a phenomenon that occurs when market orders are placed during periods of elevated volatility, as well as when large orders are placed at a time when there is insufficient buying interest in an asset to maintain the expected trade price.
Slippage can either be positive or negative. A positive slippage occurs when an order is executed at a better price than expected. For instance, if you are buying the EURUSD pair at 1.2050 but the order is executed at 1.2045, you have a price that is better by 5 pips. On the other hand, a negative slippage occurs when an order is executed at a worse price than expected. For instance, if you are buying the GBPUSD at 1.4040 but the order is filled at 1.4045, you have a price that is worse by 5 pips. Due to the fast pace of price movements in the financial markets, slippage may occur due to the delay that exists between the point of placing an order and the time it is completed. It is a term that is used by both forex and stock traders and, while the definition is similar for both types of trading, it occurs at different times for each of these forms of financial trading.
Why Slippage Occurs
When trading forex online, slippage can occur if a trade order is executed without a corresponding limit order, or if a stop loss is placed at a less favourable rate to what was set in the original order. Slippage occurs during periods of high volatility, maybe due to market-moving news that makes it impossible to execute trade orders at the expected price. In this case, forex traders will likely execute trades at the next best asset price unless there is a limit order to stop the trade at a particular price. In the case of stock trading, slippage is a result of a change in spread. Spread refers to the difference between the ask and bid prices of an asset. A trader may place a market order and find that it is executed at a less favourable price than they expected. For long trades, the ask price may be high, while for short trades, slippage may be due to the bid price being lowered. Stock traders can avoid slippage during volatile market conditions by not placing market orders unless they are completely necessary.
Reducing the Effects of Slippage
Although it is impossible to avoid the spread between entry and exit points completely, there are two main ways to mitigate them and minimise slippage:
- Changing the type of market orders:
Slippage is a result of a trader using market orders to enter or exit trading positions. For this reason, one of the main ways to avoid the pitfalls that come with slippage is to make use of limit orders instead. This is because a limit order will only be filled at your desired price. At AvaTrade, limit orders are filled at set prices or better ones, thus eliminating the risk of negative slippage which can arise when using market orders.
- Not trading around major economic events:
In most cases, the biggest slippage will take place around major, market-moving news events. It’s important to monitor the economic calendar for news regarding the asset you want to trade, because it can have a great indication to the direction in which the asset is going to move and can also help to avoid highly volatile times that occur around major news events. In day trading, it is best to avoid placing market orders during important scheduled financial news events, like FOMC announcements, or when a company is announcing its earnings. Although the resulting big moves may appear enticing, it can be difficult to get in or out of trades at the trader’s desired price. If a trader has already taken a position by the time the news is published, they are likely to encounter slippage on their stop loss, accompanied by a much higher risk level than they expected.
- Trade low volatility and highly liquid markets
Traders can limit slippage risk by trading in non-volatile and highly liquid markets. Low volatility markets are characterised by smooth price action, which means that the price changes are not erratic. On the other hand, highly liquid markets have many active participants on both sides which increases the likelihood of an order being executed at the requested price. In the forex market, liquidity is always high during certain trading hours, such as the London Open, New York Open, as well as when these two major markets overlap. One should also avoid trading or holding positions during times of low liquidity, such as overnight or weekends. This is because the prices of underlying assets may react to news or events that happened when the markets were closed.
- Make Use of VPS (Virtual Private Server)
Traders can also utilise VPS services to take advantage of the best execution at all times regardless of any technical mishaps, such as internet connectivity blips, power cuts, or computer failure. At AvaTrade, traders can run a VPS for both our MT4 and MT5 platforms and enjoy high-speed execution courtesy of optical fibre connectivity. A VPS is ideal for automated strategies and can be accessed from any location around the world 24/7.
Slippage main FAQs
- How can I avoid slippage?
Because slippage occurs during periods of volatility in the markets or when there is insufficient liquidity it isn’t possible to avoid slippage 100% of the time. The only way you could do that is to avoid trading altogether, and that’s not a good solution! Instead you can minimize occurrences of slippage by avoiding times that are known to create volatility, such as during news and economic reports.
- How does slippage affect my trading?
Because slippage is unavoidable it is something you need to account for in your trading plan. Slippage will figure into your final trading costs, alongside other costs such as spreads, fees, and commissions. One way to do this is to look at the slippage you’ve experienced over the course of a month or longer and use the average slippage when computing your trading costs. This will give you a more accurate representation of how much you need to make to record a profit.
- What is positive slippage?
When mentioning slippage most traders only think of negative slippage, where the price they receive is worse than the one they were attempting to buy at. However positive slippage also occurs and is actually quite common with limit orders. Positive slippage is when you receive a price that is better than the one you were attempting to buy at. For example, you might be buying GBP/USD with a limit order at 1.1965, but the order actually gets executed at 1.1962 thus getting you into the trade at a price that is 3 pips better than your order. That is positive slippage.
The Final Word
Using limit orders instead of market orders is the main way that stock or forex traders can avoid or reduce slippage. In addition, traders can expect to face significant slippage around the announcement of major financial news events. As a result, day traders would do well to avoid getting into any major trades around these times.
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