1 place in the rating! Free trading training!
SLIPPAGE IN FOREX EXPLAINED
When it comes to slippage, many investors often regard it as a negative sign. This is not always correct because slippage in reality looks like a two-edged sword. It can either award traders bonuses or bring them unwelcome losses. Taking a quick look at the article, you will find out the causes behind slippage and possible solutions to cope with it.
What is Slippage in Forex?
Slippage is the difference between the requested price of investors and the one at which trades are executed. In other words, when a currency pair’s value you expect does not match the filled price of your trade, it is time slippage occurs.
This incident often takes place in periods of high volatility and especially in fast-moving financial markets like the forex market. Particularly, the market has an enormous number of unfilled orders, which easily leads to sheer trading volume and consequently renders currency prices highly volatile. Traders end up opening and closing a position at a higher or lower price than they expected. Therefore, slippage is an inevitable phenomenon that possibly emerges in any forex trades.
For example, you open a short position of the EUR/USD. The current value is 1.18259 and you expect the value to decrease to 1.18255 in the future. Unfortunately, at the time you enter the trade, many buyers flood to the market, which results in more demands for the currency pair. No one is then willing to sell at your desired price, so you are priced at the best available rate in the market at 1.18261. The 0.6-pip difference between two values is considered a negative slippage.
One mistake that many forex trading beginners often make is ignoring slippage. Their failures to take slippage costs into account can pose them to a higher risk of bigger losses. To know exactly how slippage works, you need to find out the causes behind this phenomenon and when the biggest slippage happens. You then seek feasible solutions to reduce the slippage size.
Causes for Slippage
Many short-term traders who use forex scalping or pipsing strategies are worried about slippage. In addition to other concerns (e.g. spreads or commission fees), slippage is another potential culprit of reducing their estimated profits. Slippage and its size depend on various factors such as market volatility, liquidity, trading account type or order type.
Firstly, as mentioned, slippage takes place when the market is highly volatile and less liquid. The high market volatility refers to the dramatic change of a currency’s value in a short time. Looking at the picture below, when the EUR/USD value increased by 240 pips (from 1.17717 to 1.17957) before going down by 83 pips, the volatility is high.
1 place in the rating! Free trading training!
(Source: Trading View)
The high volatility is closely correlated to the low liquidity in which a currency pair is hardly traded in significant volumes without considerable changes in its exchange rate. The highly volatile (lowly liquid) market may result from the issuance of major economic news, political events, or even natural disasters.
Take the Brexit turmoil as an example. Right after the EU Referendum in June 2016, speculative investors witnessed a surprising plummet in the pound’s value (from $1.48 to $1.15) before bouncing back when the majority of Conservative members were predicted. The Brexit aftermath made the pound more volatile and worried speculative traders due to incurred slippage costs they had to confront.
Besides, currency pairs also have different levels of volatility and liquidity.
Secondly, any delays between the times when an order is placed and executed may trigger off slippage. When a trader uses accounts that have slow execution speed or delayed pricing data, they give prices more time to change before he fills his orders. Hence, slippage in this case is not a surprise.
Thirdly, slippage is inevitably susceptible to market gaps. These two concepts are different, so do not confuse them. In the forex market, market gaps primarily happen over the weekend when a currency pair’s value moves up or down without any trades taking place between because the market is closed at that time. The phenomenon can arise when unexpected major news or economic data are informed.
(Source: Market Traders Institute)
When the gap moves up (like in the above picture), it means no investors are willing to sell at those gap levels. Meanwhile, the gap that moves down as no buyers wish to buy at those gap levels, which directly forces the market to decrease the buy price. No matter which direction the gap moves, slippage still occurs when traders cannot fill their orders at their expected price.
Last but not least, slippage is also caused by order size. It means when you trade with a large position, and there is an insufficient volume at your indicated price, you have to find additional investors who can offer different prices from the initial price.
Assume that you open a 100,000-unit position of the EUR/USD and expect the price of 1.18259. Yet no sellers are incapable of providing you with that amount. So your current order book has some offers as follows:
|Volume offered||Ask price|
Accordingly, your large order will be filled by taking the first four offers and 10,000 units of the fifth offer. Only the first offer satisfies your request in price and you end up paying up to the maximum 1.18266 for your trade. Slippage is a result of the big gap between your position size and the real volume provided in the market.
Another question that concerns traders is when slippage most commonly happens. According to information offered in this part, you can deduce that slippage in forex trading mostly takes place when the market is highly volatile and lowly liquid, especially on less traded currency pairs like the exotic ones. Besides, the biggest slippage also takes place around major political or economic events or when you trade on market orders.
Solutions to Avoid Slippage
To limit the appearance of slippage in your trades, you should take some actions suggested as follows:
- Avoid currency pairs and trading times that have high volatility
The forex market is inevitably a fast-moving and volatile market. So traders can limit the risk of slippage by trading the least volatile (or most liquid) currency pairs such as EUR/USD or USD/JPY and avoiding the most volatile ones like the exotic pairs (e.g. USD/TRY or USD/KRW).
Having said that, slippage can easily occur even on those liquid currency pairs if you:
- open positions before or during the major news release;
- hold trades when the forex market is closed – particularly, over the weekend;
Therefore you should avoid trading at those times.
- Use limit orders instead of market orders
Unlike market orders, limit orders allow speculators to fill at their predetermined price or better. For example, the EUR/USD is traded at 1.18259. You enter a long position, place a limit entry order and want to buy at 1.18299. If the price equals or is greater than your specified value, the limit order will be executed. This helps you control slippage even in volatile markets or conditions.
The downside of this order is that it gets only processed when your pricing conditions are met. That is, if the price never reaches your requested price or better, you will continue being stuck in the trade and cannot fill the order. At that time, you may think that you would rather use market orders and sustain losses from slippage than waste time with the limit order.
- Avoid holding trades when major political or economic news is released
Holding a position when important economic or political events are informed, you can be confronted by considerable slippage, especially if you are following short-term strategies. Therefore you should not trade before or during those events; entering trades afterward is more advantageous as it helps reduce slippage.
Having said that, even when you open a position after those events, you can still encounter slippage induced by other factors or sudden announcements. But slippage is a part of forex trading, so using risk management tools and techniques will mitigate the occurrence of slippage.
To know which upcoming events will take place, you should frequently check up the economic calendar to be better-informed about currency pairs you are trading and the current situations of relevant financial centers.
- Register for ECN and STP accounts if possible
ECN (Electronic Community Networks) and STP (Straight Through Treatment) accounts give investors direct access to the interbank market and market participants respectively. This speeds up order execution and curb delays, accordingly mitigate slippage.
However, not all brokers provide those account types. So, if you trade with standard accounts, you can follow up with other mentioned rules to minimize slippage.
Slippage Not Always a Bad Thing
Coming back to the initial example of the EUR/USD, what if the price moves in a trader’s favor? When the supply is reported higher than the demand, the currency pair’s value will drop to 1.18219, lower than what you expected (at 1.18229). This 1-pip difference is called a positive slippage. Therefore, slippage is not always a bad thing.
Slippage is a very common phenomenon in forex trading. It happens when your expected price is different from the filled one of your orders. Many factors that result in slippage include high volatility, low liquidity, order types, account types, and market gapping. Although there are various risk management techniques to control slippage, this does not mean your trades can stay away from this unexpected incident. Instead of fearing losses incurred from slippage, you should adopt suitable strategies and tools to reduce the risk as much as possible.
1 place in the rating! Free trading training!