If you have ever traded in the forex market and noticed that your entry price was different from what you expected, you have experienced forex slippage. This often occurs in fast-moving markets, particularly during periods of high volatility or low liquidity.
Slippage is common in trading, but many people misunderstand it. Understanding how it occurs can help you lower the risk of losing money due to negative slippage and capitalize on positive slippage.
For beginners, slippage can be frustrating. However, for experienced traders, it is just a regular part of the trading process. In this article, we will explain what forex slippage is, why it happens, the types of slippage, and how traders can lessen its impact.
What Is Price Slippage?
Price slippage occurs when traders are forced to accept a price different from the one they initially wanted due to a sudden market change.
Understanding slippage is crucial since it affects your trading costs, along with other fees. Slippage occurs when a market has low liquidity, meaning there are fewer people available to take the other side of a trade, or when there is high volatility, causing rapid price changes.
When you place a buy or sell order, you expect it to be filled at your chosen price. However, if slippage occurs, the bid/ask spread may change between when your broker submits your order and when it gets executed by an exchange or market maker, resulting in a different price.
Slippage is more likely to occur during major market events, such as central bank announcements or the release of earnings reports outside of trading hours. These events can lead to price changes overnight and cause gaps when the market opens.
How Do Forex Slippages Arise?
Slippage can happen at any time during trade. This typically occurs when the rate of price change is high, often triggered by market fluctuations.
Some of the main reasons for slippage include:
1. Market Volatility: Price fluctuations can happen quickly due to major news releases, economic reports, or events that might cause immediate price changes. During these times, it can be not easy to trade at the prices you expect, leading to slippage.
2. Low Liquidity: It is expected that slippage is greater where market liquidity is relatively low. In this context, liquidity refers to the ability of an asset to be traded without any changes in the price level. The slippage of the asset tends to occur when there are insufficient buyers and sellers at the relevant price.
3. Order Types: Some kinds of orders are much more likely to suffer slippage than others. For instance, market orders that deliver the price of the most easily available option provide risk slippage compared to limit orders that specify a corresponding price for order execution.
4. High-Impact News Events: Price changes usually happen due to news announcements. These can be about interest rates, economic data, or political events. When these changes occur, traders can take advantage of them as the market quickly shifts from one level to another.
5. Execution Speed: After order receipt, slippage may be impacted by the time taken to process the request.
Positive vs. Negative Slippage
Slippage isn’t always a bad thing—it can work in your favor or against you:
- Positive Slippage: You get a better price than expected. For example, if you place a buy order for EUR/USD at 1.2000 but the trade is executed at 1.1995, you’ve saved five pips. This can happen when the market moves in your favor before your trade is filled.
- Negative Slippage: You get a worse price than expected. If you place a sell order at 1.2000 but the trade is executed at 1.1995, you’ve lost five pips due to slippage. This increases your trading costs or reduces your profits.
Both types of slippage are common, and even experienced traders frequently encounter them. The key is to understand how slippage affects your trades and how to minimize its negative impact.
How Slippage Affects Your Trading
Slippage can have a significant impact on your trading performance, particularly if you trade frequently or hold prominent positions. Here’s how it affects you:
Increased Trading Costs:
Negative slippage means you’re paying more to enter or exit a trade. For example, if you’re buying a currency pair and experience three pips of slippage, you’re starting the trade at a slight disadvantage, which can reduce your profit margin.
Impact on Scalping Strategies:
Scalpers aim to make small profits (often 5-10 pips) from quick trades. Even a few pips of slippage can turn a profitable trade into a loss, making slippage a big concern for scalpers.
Stop-Loss and Take-Profit Issues:
Slippage can cause your stop-loss or take-profit orders to be filled at worse prices than planned. For example, if your stop-loss is set at 1.1950 but the market gaps to 1.1940, your trade might close at a larger loss than expected.
Compounding Effect in High-Frequency Trading:
If you place many trades daily, small amounts of slippage can accumulate, significantly impacting your overall profitability.
Psychological Impact:
Frequent negative slippage can be frustrating. It may lead you to make emotional decisions, such as abandoning your trading plan or taking unnecessary risks to recover losses.
Slippage and Different Order Types
Understanding how different order types interact with slippage is key to managing it effectively:
Market Orders:
These are executed immediately at the best available price. They’re prone to slippage, especially in volatile markets, because the “best” price can change rapidly.
Limit Orders:
These let you specify the exact price at which you want to trade. For example, set a limit order to buy EUR/USD at 1.2000. If the market reaches that price, your trade is executed without slippage. However, if the market doesn’t hit your price, the trade won’t execute.
Stop Orders:
These are used to enter or exit trades at a specific price. For example, a stop-loss order might be set to sell at 1.1950 if the market moves against you. In fast markets, stop orders can experience slippage because they’re filled at the next available price.
Stop-Limit Orders:
These combine a stop price (to trigger the order) with a limit price (to control the execution price). For example, you might set a stop-limit order to sell at 1.1950 (stop price) but only if the price is 1.1945 or better (limit price). This reduces slippage but risks the trade not being executed if the market moves too fast.
Guaranteed Stop-Loss Orders:
Some brokers offer guaranteed stop-loss orders, which ensure your trade is closed at the exact price you set, regardless of market conditions. However, these often come with a fee or wider spreads.
How to Minimize Slippage
While you can’t eliminate slippage, you can take steps to reduce its frequency and impact. Here are practical strategies:
Trade During High-Liquidity Hours:
The forex market is most active during the overlap of major trading sessions, such as the London-New York overlap (8 AM to 12 PM EST). During these times, spreads are tighter, and slippage is less likely to occur.
Avoid Trading During Major News Events:
Economic announcements, such as interest rate decisions, inflation reports, or employment data, can cause extreme volatility. Check an economic calendar and avoid trading during these events unless you’re an experienced trader.
Use Limit Orders:
Limit orders ensure you only trade at your desired price, eliminating slippage (though the trade may not execute if the market doesn’t reach your price).
Choose a Reliable Broker:
Select a broker with fast execution speeds and a good reputation. ECN brokers connect you directly to the interbank market, reducing delays and slippage. STP (Straight Through Processing) brokers are also a good choice. Avoid brokers with slow execution or a history of excessive slippage.
Trade Major Currency Pairs:
Major pairs, such as EUR/USD, USD/JPY, and GBP/USD, have high liquidity and tighter spreads, which reduces the likelihood of slippage compared to exotic or minor pairs.
Use Stop-Limit Orders:
These allow you to control the execution price, reducing slippage on stop orders. However, be aware that the trade may not execute if the market moves too quickly.
Monitor Spreads:
Spreads (the difference between the bid and ask price) widen during volatile periods, increasing the chance of slippage. Use a trading platform that shows real-time spreads to make informed decisions.
Test Your Strategy in a Demo Account:
Practice trading in a demo account to see how slippage affects your strategy in different market conditions. This helps you adjust your approach without risking real money.
Consider Guaranteed Stop-Loss Orders:
If your broker offers guaranteed stop-loss orders, they can protect you from slippage on stop losses, though they often come with additional costs.
Use Lower Leverage:
High leverage amplifies the impact of slippage on your account. By using lower leverage, you reduce the financial impact of slippage on your trades.
Keep a Trading Journal:
Record details of your trades with a trading journal, including any slippage, to identify patterns and adjust your strategy.
Slippage and Risk Management
Slippage can directly affect your risk management, especially when using stop-loss orders. Here’s how to integrate slippage into your risk management strategy:
Account for Slippage in Risk Calculations:
When calculating your position size and risk per trade, factor in potential slippage to ensure accurate results. For example, if you risk 1% of your account per trade, assume a few extra pips of slippage to avoid exceeding your risk limit.
Widen Stop-Losses Slightly:
In volatile markets, consider setting your stop-loss a bit further from the market price to account for potential slippage. However, balance this with your overall risk tolerance.
Use Guaranteed Stops (if Available):
If your broker offers guaranteed stop-loss orders, they can protect you from slippage-related losses, though they come with a cost.
Monitor Position Sizes:
Larger position sizes can be more challenging to execute at the desired price in low-liquidity markets, leading to increased slippage. Keep your position sizes reasonable, especially for less liquid pairs.
Advanced Considerations: Slippage and Broker Models
The type of broker you use can influence slippage:
Market Maker Brokers:
These brokers act as the counterparty to your trades and may offer fixed spreads. However, they can introduce slippage, especially during volatile markets, as they control the execution price.
ECN Brokers:
ECN brokers connect you directly to the interbank market, where trades are matched with other participants. They typically offer faster execution and lower slippage but charge a commission.
STP Brokers:
STP brokers pass your orders directly to liquidity providers, reducing delays and slippage compared to market makers. They’re a good middle ground for retail traders.
When choosing a broker, research their execution policies, read reviews, and test their platform in a demo account to assess slippage in real-time conditions.
Common Misconceptions About Slippage
- “Slippage Only Happens with Bad Brokers”:
- Slippage is a natural part of trading in a fast-moving market, even with reputable brokers. However, poor brokers may exacerbate slippage through slow execution or manipulative practices.
- “Slippage Can Be Completely Avoided”:
- While you can reduce slippage, it’s impossible to eliminate it due to the nature of the forex market.
- “Slippage Only Happens During News Events”:
- While slippage is more common during volatile periods, it can occur at any time prices move quickly, even in normal market conditions.
Conclusion
Forex slippage is a common occurrence in trading, but it doesn’t have to hinder your success. To minimize slippage, trade during less busy market times, use limit orders, select a reliable broker, and employ innovative risk management practices.
With experience, you’ll learn to expect slippage and include it in your trading plan. With the right tools, you can navigate the forex market and turn challenges like slippage into opportunities. Happy trading!
