Minding the Gap
If you’ve only recently joined the ranks of live traders, the term slippage might sound foreign. For beginner traders who are only used to demo trading or theoretical trading from their studies, slippage is a nonexistent phenomenon. This is because education only deals with theory and prices in a lab environment. In reality, price and quote feed suppliers commonly experience glitches on prices. This flaw in pricing is the event seasoned traders call slippage.
When you place an order on a live trading account, whether it’s a pending future order or a market order you expect to be executed right way, slippage is the occurrence of the order getting filled on a different price. For example, let’s say you want a market order to buy Euro/US dollar at 1.1130. You click at that price but the entry price which is recorded for your position turns out to be 1.1132. This means you had a slippage of another 2 pips instead of the lower price you initially requested.
The same thing occurs on limit or stop orders where you place a future price order to be filled when price hits its mark. Sometimes it could even be your stop loss or take profit which you’ll get a different price than requested.
The reason slippage is something traders who come from back testing or demo trading are not familiar with is because price is provided by technology, which in forex is incredibly complex. More so than centralized trading systems like the stock market because forex price feeds come in from multiple sources with each feed provider averaging in their preferred type of spread between ask and bid prices. The tech is not definite from one feed, one broker like in centralized markets and there are variations from feed to feed. This is why slippage by a few points can often be chalked up to variations in technical specifications.
Another reason for slippage occurring is when there is not enough liquidity or demand for a certain position – when there is a spike in the market but in between there are gaps where there was no feel for the prices. For example, if the price now is 1.1130 on Euro/Dollar, the next tick available might be 1.1140. That’s a 10 point difference and if you had a stop order at 1.1135 it would be filled only at the next available price. This would result in a 5 point slippage in pips.
Another cause is when you order a very big position that cannot be filled in one price. Let’s say you request 20 contracts of Euro/US dollar. But at this time and at this price, there are only 15 lots the exchange can offer you. What happens is you will only get filled by 15 and the remaining 5 will change their price until the exchange can find more sellers to deliver to you. Price will likely go up which will create a higher average price than what you initially requested. This creates another instance of slippage.
Occurring because of a market roll over, another type of slippage occurs in the middle of the night when all of the major banks tally up the days numbers and determine who is owed what. This days accounting happens at midnight GMT and means that many calculations are occurring in the market and the transactions for the next payment or reception is the roll over time. This creates volatility in the market and causes spreads to widen. During this brief time, prices can go up to as much as two digit gaps over several minutes. At this time, if you have any stop order or limit order, the wide gap will deliver different prices than you expected.
The last type of slippage is a bit criminal and one which we don’t see nearly as much as we used to, before regulators really clamped down on the industry. Since there’s no single forex exchange, brokers that are usually private firms and not committed to a moral set of rules used to manipulate prices. They would play with spreads and change prices as they wanted to in order to give them favorable market positions.
While this can and does still occur on rare occasions, today this is illegal and if you trade with a regulated broker, you’ll be protected by this type of behavior. However, if a broker does choose to engage in this behavior, regulators will jump in and levy huge fines.
The Best Way to Deal with Slippage
Slippage is part of market conditions. On a regular basis, slippage will occur and you won’t always get the price you had initially desired. This is simply a fact you must accept in order to not pull your hair out when it inevitably occurs. In order to avoid, or rather cope with it, you should have enough margin for error to let your trade in. When you start a trade, ask yourself what will happen if it gets executed at a slightly different price. How much would that affect the outcome that you’re expecting. For example, if you trade in order to take a very tiny profit, slippage will affect your trading efficiency very much. If you trade bigger rallies, slippage that may occur would have less of an impact.
On the exit point of view, it’s usually placed with stop orders or limit orders, you’ll have less that will affect you. For the stop loss, if slippage occurs when price should get to your stop loss, it might take slightly more risk than you were expecting. In order to get this, you can shift your stop loss further so the risk you’re willing to take doesn’t come to fruition. You should also know that in the places behind support or resistance level, usually there are a lot of orders waiting there and price will snap and create fake outs and gaps. If you place your orders around these areas, a lot of events that cause volatility will create slippage.
Another method to avoid slippage is to avoid trading during economic events. There are calendars with economic events readily available for purchase. It’s recommended you pick one up so you’re aware of important upcoming events.
The last way to steer clear of slippage for your stops is to not let the market hit your predefined stop loss level but to exit the market by clicking the exit button on your trading platform rather than wait for your order to be executed. This allows you to cut the amount of loss if you see volatility rising. A simple click out of the program will help you avoid extra risk.
As we mentioned before, slippage is simply part of the market. It’s akin to a condition you might have in weather, like a rain shower, snow storm, or wind gust. Sometimes these events are forecasted, other times they just appear. Traders who are new to live markets can be hit by this as a surprise. The first step to coping with slippage is being aware that this phenomena happens and will happen to you. Limiting your losses and minimizing your risks are, as always, the keys to success in the forex market.