5 March 2024 - 8min Read

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What is slippage in trading — how to avoid it?

Have you ever come across a situation where your order wasn't executed at your desired price? The most common reason for that is slippage. It typically happens when the underlying market price moves sharply during or after a major market-moving event. Examples would include an unexpected interest rate move, or a geopolitical surprise.

When trading forex, you may notice a little variation between the price at the time that you hit a trade button and the execution price. This happens because of slippage. It's a typical occurrence for forex traders and can have a favourable or unfavourable impact.

Slippage is caused mostly by volatility and execution speeds. A market with significant volatility where prices are jumping around rather than transitioning smoothly usually indicates a lack of liquidity. This insufficient liquidity can result in traded prices leapfrogging over or under order levels. If this occurs, the liquidity provider will offer or execute the trade at the next best price. This is called a requote.

In the example of an Electronic Communication Network (ECN) account, execution speed is the speed at which your ECN can execute your order at your desired price. With prices changing in fractions of a second, fast execution times may make a significant impact, particularly on big trades. ECN accounts always promise faster execution speeds, usually referred to as “lightning fast executions” in marketing lingo.

TABLE OF CONTENTS

Key takeaways

  • Slippage refers to the situation in which a market order is filled at an execution price different from what was quoted at the time that the trade button was hit.
  • Slippage happens when the bid/ask spread changes between when the buy/sell button is hit and when an exchange or another market maker executes the order.
  • Slippage happens when a trade is executed at a price higher or lower than the quoted price, often occurring during high volatility or low market liquidity.
  • Slippage happens in all markets, including individual equities, stock indices, bonds, currencies, and futures contracts.
  • Positive slippage results in a better price, while negative slippage results in a worse price.
  • Market orders expose traders to slippage.
  • It's also a good idea to avoid trading over significant news events, as this might lead to slippage.

Marc Aucamp

Content Writer

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What is slippage in trading?

Slippage is the difference between the projected price at which an order is set to be executed and the actual price at which the broker executes it. 

Positive slippage occurs when a trader receives a better price, and negative slippage occurs when the trader receives a worse price. Because a market's bid and ask prices are constantly changing, a tiny degree of slippage is a regular market event.

For example, when a ‘buy’ trade is placed, there are three possibilities:

  1. There is no slippage since the trader buys the asset at the same price that exists in the market.
  2. Slippage results in a purchase at a  lower price than that initially quoted, as the price decreased immediately before their order was executed, resulting in positive slippage.
  3. Negative slippage occurs when a trader pays more than the quoted price as it increased before their order was executed.

Slippage may happen with market, stop, and limit orders. But traders can never suffer from negative slippage with limit orders, as these give an absolute limit on the price at which something is purchased or sold. The downside to a limit order is that the price may not reach the desired limit, so the order isn’t executed. A market order will always be executed, as long as the market is open, but the price cannot be guaranteed.

How does slippage work?

Slippage refers to any difference between the quoted price and the execution price. When executing a trade, the asset is bought or sold at the best price available from an exchange. This may result in better, equal to, or worse outcomes than the anticipated execution price.

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Why does slippage occur?

You can often experience slippage if you trade exotic forex pairs. That's because there's frequently less liquidity in these pairs. We know for a fact that with less liquidity, it can take a relatively long time for a counterparty to match your order. Although we still refer to fractions of a second when we say "long time." Even so, it can be sufficient time for the market price to change.

Important macroeconomic or geopolitical developments, or even a mildly angry Twitter exchange between representatives of governments can all trigger considerable market volatility. When prices shoot up and down, the result is often an increase in the instances of slippage. 

Slippages also occur when traders try to close out significantly large positions. Each market has different levels of liquidity, or depth. It can help to visualise this as a ledger, or ladder,  with rows of pending orders from specific institutions and liquidity sources.

The middle rows represent the best bids from buyers and offers from sellers, and when there’s good market depth, these tend to be closely matched and represent the prices shown on the platform.  Buy orders at lower prices stretch to the downside, while sell orders are ranked to the upside. 

Each of these rows can only fill a certain number of lots or shares in the case of individual equities. So, if you want to trade a significantly large position,  a market order may be split and traded at prices spread over many rows. As a result, the ultimate price will be the weighted average of numerous rows, changing (requoting) the price from that shown on the trading platform.

How to avoid slippage?

Forex slippage may also occur on standard stop losses. When the stop loss price is hit, the stop loss order instantly becomes a market order, which means it must be filled regardless of price. In fast-moving markets, this could mean that the stop loss order is filled at a less favourable price than the one anticipated. However, "guaranteed stop losses" are quite different from standard stop losses. Guaranteed stop losses will be fulfilled at the set level and filled by the broker regardless of the underlying market conditions. Essentially, the broker will bear any loss incurred due to slippage. Traders can set guaranteed stops on many different markets and there is a modest charge for this service. 

Major news events may cause the markets to fluctuate wildly, increasing the chance of slippage for traders. Monitoring the economic calendar to be aware of when important data is due for release or when an economic event is taking place, will help you prepare for times when volatility may shoot higher. This may assist you in avoiding extreme situations that often develop during that time.

Trading on low volatility or highly liquid markets is another way to possibly decrease or eliminate slippage. Many markets with low volatility have smooth price movements, where price changes are small. Furthermore, these markets are often made up of many active traders, which increases the likelihood of orders being filled at the preferred price. 

A limit order is when a trader instructs their broker to sell or buy a financial instrument at a specific price in the future. This is distinct from a market order, which is an instruction to your broker for them to buy or sell at whatever price is currently available in the market.

Requotes

For particularly large orders, or in ‘fast markets’ when prices are changing at great speed,  some brokers may re-quote the price. When a broker is unable to complete an order at the price you requested, it imposes an execution delay and returns the request with a new, generally less favourable price.

You will then be able to trade at the new price. Of course, with very fast markets, any delay in accepting the re-quote may result in the price being withdrawn, and you may receive a  second re-quote.  While this is unfortunate, it can happen if the market moves rapidly during the release of major economic data, for example.

The requote message displays on your trading platform, informing you that the price has changed and allowing you to accept the new quoted price. Price requotes are inconvenient, but it just reflects the fact that prices change fast.

Final thoughts

Although slippage can occur across most asset classes, financial instruments with high trading volumes tend to be less susceptible to it.  Yet slippage cannot be completely avoided. Consider it a factor of trading. To ensure you get the price you want, use limit orders. But bear in mind. There’s no guarantee that your limit order will be filled as the price may never reach your order level. If you’re not too worried about the price, use a market order to ensure that your trade is filled, although there may be some price slippage.


People also asked

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Slippage tolerance is a percentage of the position you are prepared to tolerate in slippage. This term is most often associated with cryptocurrency trading platforms. In conventional markets, you can use a limit order rather than specifying a slippage tolerance.

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This is essentially a matter of personal choice. Most traders know the volume at which their trading strategy performs best. To ensure you're decreasing slippage risk, seek high-volume assets that trade tens of millions of lots daily.

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Slippage is most likely to occur over important news events. Many stock market gurus encourage day traders to avoid trading when economic data is released. While trading during economic events may seem appealing, entering and exiting a trade at your desired price might be more difficult.

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