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.
In this article, we will look at what slippage is and how you can avoid it as a trader.
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.
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.
Leading causes of slippage
There are three main causes of slippage.
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.
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 no enough players in the market, which leads to low liquidity.
When this happens, there could be a delay.
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.
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 avoiding the 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.
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.
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 limit 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 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