What is Slippage and How Do You Avoid it in Trading?

The forex market is characterized by the fact that there are no trifles in it. Any seemingly insignificant detail over a long distance can turn into significant drawdowns. Let us pay attention to any price chart - the quotes are changing every second. Many trading strategies are based on such insignificant fluctuations, or, as they are also called market noise. Scalping, pipsing strategies - the aim of trade here may be just a few pips or tens of pips. But there are a lot of positions during a trading session. And imagine that during the execution of each order there is a delay in which the price goes just one point. That is, one pip is lost. And if there are a hundred such trades in a trading session? That's a hundred points lost every day. No doubt, everyone faces slippage. This phenomenon affects the return potential of a trade, so it is important to understand why it happens and whether possible losses related to slippage can be prevented.

There are a lot of misconceptions among novice traders about price slippage. Since we are talking about the difference between the order placing price and the price of its execution, many do not understand how this situation differs from the spread. In fact, the difference is conceptual. In this article, we will explain in detail the mechanism of slippage and tell you how to protect yourself from it.

What is Slippage?

Broadly speaking, slippage is when an order is executed at a different price than it was when it was opened. That is, between two events there is a jump in quotes. There can be different reasons for this, for example, the important news that influenced the market. The slippage can sometimes be significant, up to several hundreds of points.

The possibility of price slippage for a trader depends on the orders placed. There are two types of orders - limit and stop. Limit orders are executed at a set price that is more favorable than the price at the moment of placing the order. That is, the trader wants to buy the asset at a price lower than at the moment or sell it at a price higher than at the moment. And he gets this opportunity as soon as the asset moves in the desired direction, strictly at the specified buy/sell price. As opposed to the limit, the stop is executed at a price less favorable than the price at the time of the order placement. If it is a buy order, it will have a price higher than the current market price. If it is a sell order, it will have a price lower than the current price. This is a kind of insurance mechanism, which allows for avoiding financial losses in case the price deviates from the predicted one.

A limit order reflects the trader's desire to open a position at the price that is most beneficial for him. Such an order actually represents an order to buy/sell. The order will be executed immediately when the value of the asset reaches the specified point and the other trader agrees to accept it. Therefore, limit orders are always executed at a specified price. Stop orders have a slightly different purpose - to buy/sell an asset when its quotes reach the value specified in the order. At the closest to the value specified in the order.

Based on the differences between the types of orders, it becomes clear that a stop order is not fully a bid to buy/sell, because such an order cannot be immediately placed in the market. After all, then it will be instantly executed on terms that are disadvantageous to its creator. The stop order will be executed when the market reaches the specified price. In fact, at the first similar price, which will be available to the broker.

Let us look at an example. The trader sets a stop to buy at the value of the asset 1.2315. This means that the order will enter the market only when the value of the asset first reaches 1.2315. However, prices do not always change uniformly and do not always increase by exactly one pip. In other words, the situation when the price is equal to 1.2315 may not occur. The nearest price can be 1.2318. The order will be executed at this price. The difference between the price set by the trader and the actual order execution price will be 3 pips. This is the slippage.

Often price slippage is comparable in size to the spread size for the target asset, that is why beginning traders confuse the two notions. Technically, the special case of slippage is a gap when at market opening (for example, after the weekend) a considerable gap is formed between the prices at closing and opening. The reason for that is that while the market was idle, significant events may have occurred that affected the quotes.

Positive and Negative Slippage

Slippage of pending orders occurs in all markets. Currencies, cryptocurrencies, stocks. There is always a probability that the price chart will "jump" several points at once. Since the price can move in any direction, there are two possible situations, which are called positive and negative slippage.

The positive slippage is when the price of the asset decreases when the order is placed to buy or rises when the order is placed to sell. In other words, you wanted to sell at 1.0056, for example, and sold at 1.0058 because of the slippage, and gained 2 extra points. Such a situation is rare, but still possible in markets with high volatility.

Much more often traders face negative slippage. it is when the buy order is executed and the actual price of the asset is higher than the declared price. And vice versa - when the sell order is executed and the actual price is lower than the declared one. In this case, possible losses depend entirely on the magnitude of slippage.

What Causes Slippage

We have considered the mechanism and types of price slippage, with only a glimpse at the causes. Now let's focus on them by identifying the key factors that cause asset price slippages. Knowing these causes is critical, so you understand how to protect yourself from potential slippage losses.

Volatility

Volatility is a financial measure that reflects the change in the value of an asset over time. Volatility can be tracked over an hour, a day, or a week. The higher it is, the greater the "range of movement" of the price. Volatility changes naturally depending on the sum of factors affecting the value of the asset.

For example, the volatility is naturally lower at night, but volatility increases greatly when important news affecting the financial markets is released. In addition to the news and the economic situation, the volatility is also affected by the total number of trades currently carried out with the target asset. Accordingly, the higher the volatility, the more discrete (jumpy) the quotes move on the chart. And the more likely is the price slippage.

Speed of Order Execution

The speed at which your orders are executed reflects the time interval from the moment the broker sends the order to buy/sell the asset up to the moment of the actual buying/selling. The shorter the interval, the better, since the value can change in the intervening time and the order will close at a price that differs from the one you have specified.

The speed of order execution is determined by the software used by the broker, the process itself is automated. Execution within 300 milliseconds is considered a norm. Execution within 1 second is often not critical, but execution longer than 2 seconds is a big problem, as the price changes greatly during that time, providing slippage of at least a few dozen points.

There are two subtleties. First, the declared speed of execution of orders of many brokers is different from the actual speed. The instant execution is not possible due to technical reasons, because the processing of the information still takes some time. Secondly, some factors cannot be influenced by the broker. For example, the presence of counter requests and the capabilities of liquidity providers.

Type of Order Execution

As we have mentioned above, limit orders are executed strictly at the set price, but their execution is not guaranteed, because there can be more favorable offers on the market. Besides, partial execution is possible if the volume of the counter request appears insufficient.

Stop orders (market orders) are executed in full volume, but price slippage is possible. The best value offer may not have sufficient volume, then the remaining volume will be accumulated from the bids at a less favorable value. This can lead to the fact that the average price of the transaction will differ from the market quote at the time of execution of the order, and, of course, it will be less favorable. At the big positions, such a moment is the most appreciable.

Please note that there may be other nuances with the types of orders as these types depend on the functionality of the trading terminal that you are working with.

Type of Trading Account

In the forex market, in addition to the categories of demo and real accounts, which we will not dwell on, there are the following types of accounts:

Standard account. This is the most popular type of account, especially among beginners. It is characterized by availability and indiscriminateness to the deposit size, high value of leverage, the average speed of transactions execution, and wide range of traded instruments;

ECN-account - interbank trading. It is characterized by high speed and accuracy of trade order execution, relatively low leverage, and smaller spreads;

HDD or STP accounts. The main difference between this interbank account type is the way of processing the trader's order. It is characterized by high speed and accuracy of trade order execution, absence of intermediaries and conflicts of interest, and minimal commissions.

Why Is Slippage So Dependent on Liquidity?

Liquidity is defined as when an asset can be sold quickly at a price that is as close to the market value as possible. Based on the definition, it is obvious that price slippage is less noticeable in more liquid markets. This is because prices change permanently, but often uncritically. This may apply to, for example, popular currency and cryptocurrency pairs.

Accordingly, less liquid markets (say, precious metals or unpopular altcoins) are much more dangerous in terms of possible losses due to slippage. Because in those markets, price spikes tend to be sudden and significant. The good news is that if you know the current market cap, you can calculate the approximate slippage. Another tool is spread control because the spread is always inversely related to the liquidity of the asset.

How is Slippage Different From Spread?

Spread is the difference between the bid and ask price. The bid is the highest price at which traders are willing to buy an asset. Ask - the lowest price at which traders are ready to sell it. Bid and Ask prices arise naturally from the traders' desire to trade on the most favorable terms (everyone wants to buy cheaper and sell more expensive).

Because of the spread, a trade that is just opened is always showing negative balance, because you bought the asset at the Ask price and you will sell it at the Bid price. The broker takes the spread because doesn't want to take losses because of your interbank trades. This is how the spread differs from the price slippage. The spread is always there, and it is set by the broker. Slippage cannot be affected by the broker, and it only appears periodically in response to external factors.

Is Slippage That Bad?

Most traders think that forex slippage is bad. Thus, it gives the impression that the broker is manipulating the trader's account. In fact, there is nothing wrong with slippage. On the contrary, it indicates the reality of the market. That is, trading is carried out on the interbank market. Often slippage can be observed on Standart, STP, ECN, and other trading accounts, which depend on the volume of the trader's position.

To sum it up, it is safe to say that slippage in the forex market is normal.

How to Minimize Potential Losses Caused by Slippage

Having determined the factors influencing the slippage, you can move on to the ways to reduce the losses from this phenomenon. Working out the ways should be based on the trader's trading style. If a trader is practicing medium or long-term trading, the slippage criticality is not so high due to a small number of trades with high-return  targets. Scalpers should proceed as follows.

First of all, it is necessary to study the trading conditions of different brokers. The broker advertising "instant execution" of orders and having the function "slippage limitation" in the terminal should be chosen. A good way to choose is to visit the forums that specialize in short-term trading - the reviews of brokers' work will allow you to choose an intermediary with minimal slippage.

Identify trading times with high market volatility and try not to open positions at those times. This tip is not suitable for trading strategies that use highly volatile trading instruments.

The macroeconomic news release causes increased market interest in the currency pair for which the news is published. Traders who do not trade on the news are advised to refrain from trading in the periods before and some time after the news release. The macroeconomic news release can not only allow earning but also as a result of slippage can lead to a significant loss.

When it comes to choosing a trading account, short-term traders should pay attention to the conditions provided by ECN, HDD, or STP trading accounts. Most brokers have these types of accounts. These accounts can provide the required speed of execution, excluding the appearance of slippage. Scalpers will appreciate the work on the STP account. The trades are executed with the highest possible speed and accuracy. The absence of intermediaries not only increases the speed of processing trading orders but also increases the security of trades - the possibility of intentionally delayed execution of orders by unscrupulous intermediary companies is excluded. STP-account is an excellent working tool for experienced traders, designed to work with large amounts of funds.

The preferred type of execution for any type of trading is Instant Execution. But this type of execution, especially for short-term trading on volatile markets, can cause massive requotes and have a significant impact on the earnings of the trader. That is why the execution type should be selected considering other trading conditions of the strategy used by the trader.

One more way to reduce losses from slippage is the use of pending orders instead of market orders. However, it should be noted that, of course, only limit orders are executed without slippage. At the same time, stop orders can be executed with slippage. This occurs because a limit order has a predetermined price giving the broker the necessary time limit for its execution.

The Metatrader 4 terminal, used to trade the currency market, can adjust the deviation of your order price and market supply. It can be set small, then exceed the value by even a pip, and the order will not work. But this way it is not always possible to use, there are certain restrictions. It is necessary to read carefully the instructions to the terminal and conditions of the broker.

Another way to avoid slippage is not to trade during the news. The news is the main engine of the international currency market. The main danger in trading at such moments is that the fluctuations can reach hundreds of points in both directions in a minute.

It seems that there is an up movement, you will catch it, but at the moment of execution of the order, the price has gone down very strongly. Not having received a message about order execution, the trader sees that the losses are huge and closes the order fixing them. And in five minutes the price will go up again. An attempt to speculate on such price surges may lead to disastrous results.

Conclusion

While trading on the financial markets slippage is a ubiquitous phenomenon that has its objective reasons. As it has already been said, it is impossible to get rid of slippage and the phenomena related to it completely. By choosing Instant Execution as a trade order execution type and excluding slippage, a trader gets requotes (which we will talk about in the next articles), which also reduce gains. The described methods of slippage loss reduction should be used with proper evaluation of their influence on your trading strategy. When choosing a broker, one should remember that a serious broker placing traders' operations on the interbank market is unlikely to compensate traders' losses due to slippage. It can only minimize them.