Understanding Slippage in Forex
In forex trading, you might hear the term “slippage” or experience it when you start trading and not understand what it is. Slippage can have a BIG impact on how profitable you trade and can be vital to understand, both in terms of you, your broker, and the market. Below, I briefly discuss the issue of slippage in forex trading.
Slippage occurs when your broker executes a trade at a different price than the price you attempted to enter at. “Negative” slippage refers to the broker executing your trade at a WORSE (less favorable relative to the direction you want to trade) price than you attempted to enter at, and is the most common form of slippage. “Positive” slippage refers to the broker executing your trade at a BETTER (more favorable relative to the direction you want to trade) and is FAR rarer than negative slippage. It occurs because price is moving faster than can be executed at a particular price, and/or there are less available orders at a specific price level than demanded, so the broker executes the trade at the next available price in the direction.
Both positive and negative slippage can occur at market entries, limit entries or stop entries, although they are most common at market entry and there is a specific reason for that. In the case of limit and stop entries, the broker already holds your order and merely has to execute the trade with the market, BUT in the case of the market order, the trade must be passed from you to the broker and then the broker executes the trade in the market adding an extra step, distance, connection. etc.. to make the process take longer.
There are essentially 3 components to how slippage occurs and I will go into each briefly below:
- YOU: Your connection to the broker depends on the quality of your internet. The better internet connection you have, the faster you will be able to transmit orders to your broker. As mentioned above, placing forward orders essentially removes you from the equation because the broker holds the desired trade order BEFORE execution, rather than attempting to place the trade immediately after receiving it from you in the case of the market order. Having a fast and reliable internet connection is important to minimize your role in the slippage scenario if/when it happens. Placing forward orders and staying out of “fast” (news releases, high volatility times of days or pairs) or “low liquidity” markets reduces the likelihood of getting any slippage in the first place.
- YOUR BROKER: This is where the “scariest” part of slippage can occur. Bad brokers can slip you on purpose to pocket extra spread, and bad brokers might have very few liquidity providers, or very bad liquidity providers, or very bad technology to connect to the market. Your broker plays a big part in how often and how much you get slippage. Ensuring you are using a trusted, regulated and very high quality broker is VITAL in reducing the amount of slippage you will experience as a trader. Some brokers even guarantee that limit orders won’t get slipped at all (they either execute at your price or not at all).
- THE MARKET: Finally, the market plays a role. Forex trading is essentially a fast-paced, computerized auction, with millions of buyers and sellers buying and selling at the same time. The more buyers and sellers and higher volumes of money, the more “liquidity” and therefore, the “smoother” price action tends to be. At times during holidays or right after news, sometimes there simply aren’t enough buyers or sellers on the other side of your desired trade, and price can “slip” considerably or move so fast that there isn’t time to get your order filled at your desired price before the market has moved considerably.. Sticking to pairs that have higher volume, during more active times of the day and avoiding news, helps reduce the chance that the market itself will cause slippage.
Understanding Slippage in Forex
Understanding what slippage is and how it is caused is vital to you as a forex trader. Knowing the causes will help you AVOID slippage for the most part, but do understand that there is no way in my experience to avoid it completely 100% of the time. Making sure you reduce the chance of getting slippage in forex though is your best bet to experiencing it as little as possible.