Have you ever opened a trade at a certain price only to see the order executed at a different level? In the financial market, this situation is known as slippage and is extremely common. Indeed, most day traders, and even investors go through it every day.
This can be very negative for day traders, because it can decrease your profits (or even turn into a loss). In this article, we will look at what slippage is and how you can avoid it as a trader.
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What is slippage
As explained above, this is a situation where an order is executed at a different price from where you placed it. For forex, the difference could be just a few pips while in stocks and other assets, it could be significantly higher.
For example, if you buy Apple’s shares at $120, the order can be executed at $121 or $119. While these numbers might seem small, in reality, the impact of slippage in trading could be significant.
Impact of slippage on day trading performance
Slippage can have a major impact on your trading results, especially for day traders. In most cases, swing traders and investors rarely care about this lag since they focus on holding trades for several days and months.
Scalpers, on the other hand, are more exposed to slippage since they focus on short-term price movements. For example, a scalper can buy a stock at $120.05 and hope to take the profit when it moves to $120.15. As such, slippage can affect the scalpers’ profitability.
In all, this can lead to smaller profits and even unexpected losses in the market. As such, it is always important to have the issue of slippage in mind before you execute a trade.
Slippage in stocks, forex, and other assets
As mentioned, slippage happens partly because of the time lag that occurs between when an order is placed and executed. Therefore, a common question is whether this different execution happens in the same way among assets like stocks, forex, and cryptocurrencies.
Slippage happens across all financial assets. It can happen across stocks like Nvidia and Tesla and across forex pairs like EUR/USD and GBP/USD. Also, it happens in other assets like cryptocurrencies and bonds.
Positive and negative slippage
Slippage is a situation where a trade is executed at a different price than the one a trader opens. In most cases, this lag is often seen as a negative thing since it can lead to losses.
In some cases, however, slippage can also lead to a positive outcome if the price is a better one. For example, if you execute a buy trade at $10.20, a small delay can see it executed at $10.18.
Why slippage occurs
As traders, at times we forget what happens in the back-end when we execute trades. In reality, a lot happens behind the scenes because of the nature of the market.
Whenever you buy a stock, someone else must sell it. Similarly, when you sell a stock, there must be a buyer at the other side.
Therefore, slippage happens when the broker is trying to find buyers and sellers for the asset. Because of how the market is, these transactions usually happen in microseconds.
Be careful, this can work for and against you!
For example, if you buy a stock at $20 and the order is executed at $18, it means that you will make more money if you are right. However, in most cases, slippage tends to go against traders.
How order types affect slippage
Broadly, there are two main types of orders in the market: market and pending orders. A market order is one that is executed immediately and is the most common in the industry.
Pending orders, on the other hand, are where a trader directs a broker to execute a trade at a certain price. There are two main types of pending orders: limit and stop.
A buy-stop opens a buy trade above the current price while a sell-stop is where a sell order is implemented below the current price.
A buy-limit order, on the other hand, is where a buy trade is implemented below the current price. A sell-limit order is where a short order is implemented above the price.
Slippage can happen in both market and limit orders, especially in a high-volatile market. However, in most cases, this is most common in market orders. As such, most traders recommend using pending orders as a way of reducing slippage.
Leading causes of slippage
There are three main causes of this difference between order placement and order execution.
High Volatility
First, high volatility is the biggest cause of it. This happens when there is major news or economic data, that leads to large swings in the market. In this period, brokers are usually scrambling to fill orders, which can lead to these price differences.
Low Liquidity
Second, slippage happens because of low liquidity in the market. As explained above, there must be buyers and sellers for the market to work. As such, while this is a rare occasion, there are times when there are not enough players in the market, which leads to low liquidity.
When this happens, there could be a delay.
Tech issues
Third, slippage can occur because of technology issues. For example, although it is rare, a technological error behind the scenes can lead to price differential.
Internet speeds
Another important cause of slippage is internet speeds. The speed of the internet can impact how fast the broker executes the order.
For example, you can place a buy order at $100 and if the internet speed is low, the price is executed at $100.10.
How to avoid slippage
While slippage is hard to avoid, there are several approaches that can help you avoid it. First, you can save yourself by avoiding volatile periods. For stocks, you can avoid opening trades before or after a company releases its financial results.
That’s because, in most cases, that is the period when most slippage happens.
For currencies, this situation happens most when there are major events or economic releases like nonfarm payroll numbers and interest rate decisions.
Second, you can avoid slippage by focusing on popular assets that have deep liquidity. For example, in forex, you should focus on currency pairs like the EUR/USD and USD/JPY instead of exotic pairs like TRY/ZAR.
Related » The Best Currency Pairs to Trade
Further, you can avoid this by ensuring that you have fast internet and the best computer or smartphone. This is important, since, as mentioned, internet speeds can create a lag between the time when the order is placed and when it is executed.
Finally, you can avoid slippage by using pending orders. These are orders where you direct a broker to execute your trades at a certain period if certain conditions are met. They include buy-and-sell limits and buy-and-sell stops.
Although they too can suffer a little gap in the execution, they are less common than in market orders.
Slippage and risk management
Risk management is an important concept in the market. A trader who does not have proper strategies will often make substantial losses. Therefore, there are several risk management strategies when dealing with slippage.
At the basic level, you can have a good computer or a smartphone. Also, you can invest in the best internet to help you improve your trading.
Other risk management strategies that you can implement are opening pending orders and always having a stop-loss and a take-profit.
Summary
Slippage is a major issue in the market. It simply means a situation where prices of assets are executed above or below where the order is initiated.
Therefore, you need to always be aware about it before you execute your trades. Also, always avoid putting your stop loss and take profits very close to where you initiate your trades.
External Useful Resources
- Slippage in Forex Explained – DailyFx