What is Forex slippage?
A Forex Slippage occurs when a trading order is executed or a stop loss closes the position at a different rate than set in the order. For example, you wanted to by the EUR/USD at 1.1385, but the order was executed at 1.1390, so, there was a slippage of 5 price units.
To understand why a slippage occurs, you need to see the way how a trade operation,buying and selling, is executed in any market. And the currency market is not an exception.
So, to execute any trade in the forex market, there must be at least 1 seller and 1 buyer. Therefore, if a buyer wants to by an instrument, to complete the trade, there must be a seller, willing to sell the instrument at a price that will satisfy the buyer. If there is no seller at such a price, either the trade will not be executed or the buyer will have to accept the price, currently offered by sellers.
The figure shows three sellers, offering to sell the US dollar at 1.1351, 1.1352 and 1.1353 respectively. If a buyer wants to buy at 1.1349, he/she can’t do it, as no one sells at this price. The buyer may try to wait until there will be a better price. If the buyer doesn’t want to wait, he/she will have to accept a less beneficial price. In this case, it is 1.1351, as it is the lowest available price.
Yes, this is less profitable, but the trader so has a 100% guarantee that the trade will be executed.
In Forex, there are some moments when the prices are changing very quickly. Let us again see the previous example. Suppose, the buyer agrees to carry out the transaction at 1.1351, being reluctant to wait for the bid price of 1.1349. But, by the time he/she clicks on the Buy button, the market situation has already changed and there was a sharp price movement. And now, there are no sellers, offering the price of 1.1351, or even 1.1352. So, the next seller offers the price of 1.1353.
What has happened? The buyer set a buy order at the price, closest to the desired one (at 1.1351). However, as the market situation has changed by the time of the order execution, the next sell price is already at 1.1353. There no sellers offering 1.1351 or 1.1352, so the execution price will be at 1.1353 that is 0.0002 price units higher.
The difference between the intended and the actual execution price, resulted from a change in the market sentiment, is called a slippage.
When can a slippage occur?
A slippage can occur only in trading market orders rather than limit orders. Market orders, when a trader agrees to the conditions of a counterparty come into a few types.
Market buy - A trader agrees to buy/sell at the lowest price currently offered by sellers;
Market sell - A trader agrees to sell at the highest price currently asked by buyers.
Buy stop - a pending market buy set higher than the current price
Sell stop - a pending market sell set lower than the current price
Stop loss is also a pending market market buy/sell, closing the position opened.
All these orders are united by the fact that each of them is executed at the best AVAILABLE price. And this “best available” price may be worse than you expect.
What can go wrong?
Let’s take the simplest situation, trading during the news releases. As many know that during the important news publication the price may sharply change in any direction, some traders reduce their risks, moving their orders away from the current price.
It is clear from the figure that at usual time, the distance between the best sell price (1.1351) and the best buy price (1.1350) is only 1 pip, there are quite many active traders willing to trade in both directions, so you are likely to avoid slippage. During the time of important news publication, the distance between the best sell price (1.1353) and the best buy price (1.1349) is already 4 pips, and the trade volume is much less. If a buy order has been put at 1.1351, there will be a slippage, i.e. the price will slip to the nearest sell price, and the actual execution price will be 1.1353.
Therefore, if your stop loss/buy stop/sell stop works out at this time, the order may be executed not at the intended price, but at a far worse one. The same will happen if you try to put a market buy or a market sell; a moment ago, the price was good, but when you put the order, the price may be completely different.
What does the a slippage size depend on?
his question especially concerns traders employing short-term trading strategy, who practise pipsing or scalping. Spreads, swaps, brokers' commission, slippages can drop their profit to zero. When making short-term trades aimed at a profit of just a few points, slippages may ruin estimated profits completely. So, what does the volume of slippage depend on? There are several factors:
- market volatility,
- market liquidity,
- trading account type,
- order processing type.
Factor №1: Market volatility
Simply put, market volatility means the degree of the price fluctuations. If, during a minute, the price is 10 pips up and then 5 pips down, the volatility is low. If, during the same time, the price goes 100 pips up and then drops by 70 pips, the volatility is high.
The market volatility is mostly affected by the traders’ activity in relation to the instrument and by the instrument liquidity. As a rule, the more appealing is the instrument, the more funds will be invested in it and the stronger will be the price swings.
On the other hand, increased volatility may result from the low liquidity. For example, during the time of important news releases, the ltrade volume around the current price sharply declines as traders just move way the orders put.
Factor №2: Trader's account type
Account types (I don’t mean a demo account or a cent account) are characterized by a variety of criteria, an order execution speed being one of them. For example, Standard or Classic accounts are available to most traders because of moderate initial deposits and leverage, but the order execution speed in those accounts is quite average. On the contrary, ECN and STP accounts feature the high speed and accuracy of orders execution.
If you take a Stop Loss order execution as an example, then at a higher execution speed, you are more likely to reduce slippage.
Factor №3: Order processing type
Forex brokers offer two types of orders execution: Instant Execution and Market Execution.
With Market Execution, a trade is entered based on the current market situation. If there is no counter-party at the price indicated in a trader's order, then a position is opened at the “best price currently available” that will differ from the indicated one.
With Instant Execution, a trade is opened exclusively at the price indicated in a trader's order, which excludes naturally any slippages. If a trader's price is inadmissible, a requote occurs and a trader can either indicate another price or cancel a trade.
In addition, I should note that Market Execution is mostly offered by forex brokers who want their orders to be filled at the next available market price without any requotes. That is, in this case you are likely to deal with the real market, and it is suitable for all investors. If you are offered Instant execution, the broker is likely to be a so-called “kitchen”, and traders’ orders are not transferred to the real market in this case. It means that the counterparty for your trades will be the market-maker broker itself, so it will be interested in your loss.
Should you be afraid of slippages?
To please you a little, I’ll note that a slippage can be not only negative, but it also can be positive (when the actual execution price is better than you initially specified).
Hardly anyone worries about a positive slippage, so let’s try to understand a negative slippage in more detail.
Basically, a negative slippage (just like a worked-out stop loss or a canceled order) is not a disaster, if you are properly prepared for it.
First, you should keep in mind that a slippage may result not from a market situation but from a technical flaw; problems with a trader’s internet connection, delays in quotes from the liquidity provider and even a simple overload of the computer’s random access memory, due to which the trading terminal is frozen for a few important seconds. Therefore, I recommend closing all the tabs you don’t use for the time of trading and buy some USB-modem for an emergency. It is also advisable to install a trading terminal on a mobile phone / tablet with mobile Internet. In this case, your response will be as fast as possible.
Second, slippage depends on the traded currency pair. Slippage more often occurs during periods of illiquidity that is a feature of cross-currency pairs or minor currency pairs. So, you should ask yourself if trading these instruments is worth a high risk of slippages during the orders execution. You may also think over trading on the news, when the liquidity is much lower, do you really want to trade during such periods?
Third, you remember that pipsers and scalpers are most of all affected by slippages in currency trading. Slippage of 5-10 points cannot significantly affect a trader who trades on the H1 timeframe, whose stop loss is around 100 p. To reduce the chance of slippage, you can trade 5 instruments on the H1 timeframe instead of 1 instrument on the M1-M5 timeframe. The number of transactions in these cases will be about the same, but when trading on H1, slippage will affect your profit much less.
As a final touch when you put an order, pay attention to the Deviation box.
This parameter determines the maximal value of slippage when the order will be executed. For example, if you select “3” and the slippage was “5” you order won’t be executed. This precaution makes sense only as an addition to your forex trading strategy along with all of the above, rather than the only method to mitigate slippage. After all, this is a parameter “inside” a trading terminal, entirely dependent on its efficiency.
Instead of a conclusion
Summing it all up, slippage has the least impact on the traders who work with the most traded forex pairs (“Majors”) on H1 and longer timeframes, as well as those with 2 terminals installed on different devices and with 2 Internet providers.
When you open a trading account, consider ECN, NDD and STP account types, where the orders are processed as fast as possible. These recommendations are enough to minimize the impact of slippage on your trading.
I wish you successful trading!
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