Trading in the Forex market requires profound knowledge and experience to be ready for many challenges and risks that accompany trading. One of the most unexpected risks for novice investors is slippage. In this article, we will discuss the slippage the FX market can entail and discover the types of slippage and ways to minimise it.
What Is Price Slippage?
In a broad sense, slippage is when an order is executed at a different price than it was at the opening. That is, between the order placement and the order execution, there was a shift in quotes.
In other words, slippage refers to the difference between the expected price at which a trade is opened and the actual execution price at which the trade is closed; that is when the order placed on the exchange is completed at a price different from the price you requested.
Slippage occurs in all financial markets, including the stock and forex markets. However, slippage on the forex market is usually minimal since the FX market is very active and liquid.
Typically, the leading cause for slippage is the amount of liquidity. Liquidity defines how fast you can buy and sell an asset without impacting its price. The slippage percentage will be higher if there is low liquidity or low trading activity in the market for a specific asset.
Most often, slippage occurs in volatile markets, especially during elevated volatility, when major world events dramatically change the quotes during the transaction execution.
Also, price slippage may be caused by the increased number of participants who are closing their transactions simultaneously — in this case, the system may merely lack time to process a high number of transactions, and some trades will be closed at a different price.
Low liquidity in the market can be another reason for slippage. Low liquidity means that there are few participants in the market, and therefore, it may be challenging to find a buyer ready to purchase the stocks or other assets you want to sell at the specified price. Similarly, finding a seller willing to sell the item you wish to acquire at the requested bid price might be difficult.
The average slippage on forex trades depends on various factors, such as liquidity, market conditions, etc. However, according to some studies, the average slippage in the FX market is around 1-2 pips.
What Are The Types Of Slippage?
Any difference between the expected execution price and the actual execution price qualifies as slippage, regardless of whether that difference is positive or negative.
Of course, it is best to avoid significant slippage for a more stable trading experience. However, slippage does not always harm trades — the price difference can be favourable or unfavourable for the trader. Slippage can be positive and negative.
Negative slippage occurs when the ask price is higher when buying or the bidding price is lower when selling. Negative slippage happens more often, and traders lose money on it. Possible losses entirely depend on the amount of slippage.
Positive slippage is when the asking price is lower when buying or the bid price is higher when selling. For example, if you wanted to sell an asset at $1.56 but sold it at $1.58 due to slippage, you have won two additional cents. Positive slippage occurs rarely but is still possible in markets with high volatility.
Negative slippage is the most common type in all markets, including the FX market.
To improve your trading activity, it is essential to understand how slippage is calculated. Commonly, FX traders calculate it by defining the difference between the executed asset price and the anticipated asset price.
Alternatively, to define slippage, traders calculate the difference between the highest bid price and the lowest ask price; that is, they define the bid-ask spread.
Commonly, the percentage of the market slippage is calculated by the following formula:
What Is Slippage Tolerance?
Slippage tolerance is a setting that allows you to define what percentage of price slippage you’re willing to accept so that your order can be executed.
Your broker will take the next available market price if the market slips and the price tolerance is not specified. Setting a favourable price tolerance allows you to control your slippage cost by limiting the price discrepancies.
When setting a tolerance value, traders come to the question: what is a good slippage tolerance?
Experts in the field typically state that choosing lower numbers for the slippage tolerance — between 0.5 and 7% — runs fewer risks than choosing larger values, which usually range from 8% to 16%. However, the exact value depends on the type of trade you want to open.
How To Avoid Slippage In Trading
Slippage is a normal and inevitable part of trading. But there are a few ways to minimise your risk of slippage in trading. Here are some tips that can help you reduce slippage in the FX market.
- Manage risk during news events. Wait for a little after the major news event is published, and only then open an order. This way, you can take advantage of market volatility and avoid slippage. Alternatively, you can avoid trading during major news events unless you are a day trader or a scalp trader in the FX market. Thus, you can prevent significant or unexpected slippage.
- Change the type of market order. A market order is a type of order that is highly subject to slippage. Guaranteed stops, on the other hand, are not subject to slippage and can close your trade at the level you choose. As a result, guaranteed stop-loss orders are the most effective strategy for reducing the risk of the market turning against you. On the other hand, limit orders can help reduce the chance of slippage when you start trading or want to make a profit.
- Avoid trading during major economic events. Try not to trade before, during and immediately after major macroeconomic, political events, or major financial news events, as the chances of slippage are very high. It is better to wait until the news is published and then open positions. If you have an open position during the publication of important news, a stop loss can help you minimise possible slippage.
- Trade in the low volatility and highly liquid markets. If you trade during the hours with the highest trading activity and active price movements, this method can help you reduce the risk of slippage. The liquidity is at its highest level, which increases the probability that the transaction is closed quickly and at the expected trade price you require.
- Choose low slippage forex brokers. Though brokers do not control slippage, you can still opt for those with the lowest slippage, such to execute your trades at a better price or even benefit from the positive slippage.
Conclusion
Slippage is an inevitable part of trading that can happen in any market. Though negative slippage occurs relatively frequently, stock or Forex traders can sometimes benefit from positive slippage. Moreover, slippage can be controlled by setting a tolerance value and using some techniques, like trading in low-volatility markets or selecting proper order types to execute trades at a desired price.
