What is slippage in trading? — Here is how it can be avoided

Slippage is the difference between the price at which you expected the order to be executed and the actual price at which the order was executed. As mentioned above, it can occur on any market, such as forex, individual equities, stocks, or indices, when spread betting or trading CFDs.

This type of occurrence happens when the market is experiencing high volatility levels, and price fluctuations occur more rapidly and frequently.

Slippage can either be positive or negative. 

A positive slippage could occur when the price at which a position is executed is better than the expected price at which the position was initially set. And a negative slippage could be when the price at which a position is executed is worse than the expected price.

A tiny degree of slippage is considered normal because the market’s bid (sell) and ask (buy) prices are constantly changing. 

When you enter a trade, either a long (buy) or short (sell) position, three possibilities could occur:

1. There could be no slippage when the financial instrument’s price is the same as that in the market.
2. Positive slippage is when the price of the executed position is better than the price initially quoted as you enter the trade.
3. Negative slippage is when the executed price is worse than the price initially quoted as you enter the trade.

Slippage could occur with most order types, including market, stop, and limit orders. However, a trader won’t suffer from negative slippage with a limit order because these orders only get triggered once the price reaches a specified price level or better.

The downside to using these order types is if the price doesn’t reach that level, the order won’t be executed.

On the other hand, a market order will always be executed immediately as long as the market is open; however, if you are trading in a market experiencing higher levels of volatility, the price might not be guaranteed as slippage could occur in a second.

Stop-loss orders are another order type that could be vulnerable to slippage because, due to the quick price change, your order might get triggered at a worse price than the initial level when you placed the stop loss. There is also the possibility that the order might not get triggered at all.

Now, let’s look at an example of positive and negative slippage.

Let’s say you were trading the forex market and looking to enter a long (buy) position on GBP/USD trading at an asking price of 1.2310, and you opened the position with a market order. 

However, during the time of trading, some economic news came out from London, which increased the volatility for the currency pair, and the price jumped to 1.2315 as soon as you entered the position.

This is seen as a negative slippage because the price is higher than the initial price at which you requested to enter the position.

Now, let’s say the news that came out had the opposite effect on the level of volatility, and the price fell to 1.2305 as soon as you entered the position. This is seen as a positive slippage because the price is now better than the initial price.

Slippage generally occurs within markets that are experiencing levels of high volatility and low liquidity. If a market is experiencing higher volatility, price changes will happen more rapidly and frequently.

When a market has low liquidity, it means there are fewer market participants, so finding a counterparty to match your order could take longer. Although ‘longer’ could mean a second longer, this is still more than enough time for a price to change either positively or negatively.

Important macroeconomic events, geopolitical developments, or company announcements such as earnings reports or leadership changes are some factors which could also cause some markets to experience slippage.

Some of these significant economic events or news announcements could also cause gapping. A significant difference between the closing price and the next opening price of a financial instrument is defined as gapping.

In the forex market, this generally happens over a weekend if there are any news announcements. With stocks, on the other hand, gaps can occur from one day to the next day.

Slippage could also occur when traders are looking to close out a significantly large position, where if the liquidity is low, it might be difficult to close the entire order at the same price. 

It might happen that they would only be able to close half of the position at a specific price and the other half at another price, either better or worse than the original price.

There are various ways you could potentially minimise the effects of slippage when trading. Let’s have a look at what they are in more detail.

Place limit orders

A limit order is a type of order instructing your broker to execute a position at a specific price more favourable to the current market price. This means the order will only be executed when the price reaches your specified price or a better price.

Suppose you are looking to open a short (sell) position; the trade will only be executed once the market has reached your desired price or a price higher. Now, for a long (buy) position, the trade will only be executed once the market has reached your desired price or a lower price.

The position won’t be executed if the price doesn’t reach your specified limit order price.

This order type could assist in mitigating the risk of slippage, as your position will only be executed if your desired price or a better price is reached.

Place guaranteed stop-loss orders

Unlike a standard stop-loss or a trailing stop-loss, guaranteed stops won’t be affected by slippage as they will close at the exact predetermined level at which you placed the stop order, regardless of whether slippage occurs.

The only difference is that with a guaranteed stop, there is a fee payable if or when the order gets triggered.

Trade markets with high liquidity and low volatility

Markets with higher liquidity and lower volatility tend not to experience slippage to the same degree as when a market has higher levels of volatility and lower liquidity.

The reason for this is that when a market has low volatility, the price changes are more steady. With higher liquidity, there are also many market participants, which increases the likelihood of your orders being executed at the desired price.

One of the ways you could mitigate your overall exposure to slippage is by trading during hours when the market is most active and when the liquidity is at its highest.

On the other hand, slippage is more likely to occur outside of those active hours, for example, during the night when some markets are closed or over a weekend. 

The reason is that when the markets open again, prices can change rapidly due to various reasons, such as major economic news announcements or events that could’ve taken place while the market was closed.

Avoid trading around important news events

As mentioned above, major news announcements or economic events could cause prices to fluctuate while increasing the levels of volatility. 

One of the ways you could mitigate the risk of slippage when it comes to major news announcements or events is by looking at an economic calendar to be aware of when important news data is due for release. Or consider when an economic event such as the non-farm payroll is taking place.

This could help you gain a better understanding of when to avoid these situations where rapid and frequent price movements could take place in the market, which could ultimately result in slippage.

Requotes generally occur when you might want to close out a large position or when markets are experiencing price changes at greater speeds. When the broker is unable to complete an order at the price you requested, an execution delay takes place, and the request is returned to you at a new, generally less favourable price.

Once you’ve received this new price, you can either close the position or keep it open.

Due to the fast price changes, if you decide not to close the position at the new price or delay accepting the new price, the broker will withdraw the requoted price, and you’ll receive a second requoted price.

Requotes tend to happen more frequently during the release of significant news announcements or economic events.

On your chosen trading platform, the requote message will display, informing you the price has changed while allowing you to either accept the new price or not. These requoted prices reflect the fast price changes in a particular market.

It is possible for slippage to occur across various financial markets and instruments, and, unfortunately, it can’t always be avoided; for this reason, slippage could be considered a trading factor. 

However, suppose an instrument has higher trading volumes and liquidity. In that case, it might be less susceptible to slippage, so it might be better to look at certain financial instruments with lower volatility and higher liquidity levels; one way this could be achieved is by trading during hours when the market is most active.

As previously mentioned, to mitigate the risks of slippage when trading, you could take various steps such as using limit orders, for example. The only downside when using limit orders is if the price doesn’t reach your targeted price or better, the order won’t be executed.

Otherwise, you could also use a market order to execute the trade instantly to ensure your order is filled, although this order type is more susceptible to slippage.