Slippage in trading – why does it happen?
Every market, financial or otherwise, needs a buyer, a seller and a price where both parties are happy to make an exchange for a transaction to happen.
If the buyer and seller can’t agree on a price, the trade cannot take place. The price has to move until it reaches a level where both the buyer and seller are happy. Thought of another way, this means that not every possible tradeable price will attract a buyer and seller. Sometimes there has to be a significant price movement, up or down, from where the last trade took place, to find a new level where both buyers and sellers are willing to trade.
What is Slippage?
Slippage, or gapping, describes a price movement in which no trade occurs. This could be caused by anything that changes the price of a market. For instance, unexpected company news, whether good or bad, a natural disaster or political event.
Why does this situation concern a trader and is there anything that can be done to stop it from happening? As not every price that could be traded will be traded, it follows that you won’t always get the price you want when entering or exiting a market.
For example, if the price you’d like to buy at isn’t one that attracts a seller, the market will move to the next level where there is one. With a ‘market’ order*, this then becomes the price you will receive for your buy trade. So, the market has ‘gapped’ from a price where there weren’t both buyers and sellers to a price where a trade could be completed.
Clearly, it’s disappointing if the price you want isn’t available, especially if you end up buying at a higher price or selling at a lower one. This is called negative slippage. If the ultimate trade price is better for you, this is positive slippage.
How it happens
It isn’t possible to prevent slippage from happening. All markets experience pricing gaps where buyers and sellers cannot be matched. But you can guard against it in some situations. For a start, at Trade Nation we offer ‘Guaranteed Stops’ on most of our markets. Let’s say you have an open position and you’ve attached a ‘stop-loss’ to it. That is, if the market moves against you and trades at your ‘stop-loss’ level, then your position will be closed . But you’re worried about the market gapping through your stop-loss, meaning you would lose more than planned. To guard against this you can, for a modest charge, ‘guarantee’ your stop so your order won’t get fulfilled at a worse level.
You can also make sure you always leave ‘limit’ orders when you trade, rather than ‘market’ orders*. If you do this then your trade will be actioned at your ‘limit’ price or better, never worse. But you must be aware that due to slippage, the market may not trade at your limit price. If so, then your order won’t be filled.
Markets that are actively traded and liquid are less likely to experience gaps, so this reduces the likelihood of slippage applying to your trades. The FX markets, in particular the Major FX pairs, are a very good example of this. Trillions of dollars’ worth of trades are made in these markets every day, increasing the chance that buyers and sellers will be found at each price.
But a smaller and little-traded market is more likely to see significant price gaps, especially when political news or key economic numbers are released. It is essential that you completely understand the market you are trading ( read our blog on Trading Safely) and the likelihood of slippage occurring before you begin to trade.
You can’t avoid the risk of slippage. It happens every day in every market. But understanding how prices can sometimes move and how this might affect your trading will help you make better choices when it comes to managing risk.
*A ‘market’ order is where a buying or selling price hasn’t been specified. In other words, there is no limit on either how high the buying price could be, or low the selling price.