What is Slippage in Forex Trading?
Slippage in a forex market occurs during times of extreme volatility. It helps understand how currency pair prices have moved against the fixed market prices. Traders can set their slippage tolerance to avoid price volatility risks and fix a certain percentage beyond which orders are not executed if slippage is higher. In our article, we will understand everything about slippage and how to avoid it.
What is slippage?
Slippages occur when a currency pair order is executed at a price different from the set market order price. It is calculated as the difference between the expected market price and the current market price at the time of order execution. Slippage occurs during high volatility periods as currency pair prices fluctuate rapidly. When a large market order is placed during a low buying pressure, it’s hard to maintain the currency pair’s price expectations. Slippage is of two types –
- A positive slippage is when your trade is executed at a better price than set in the market order.
- A negative slippage is when your trade is executed at a worse price than set in the market order.
How does slippage work?
Any change in the value of a currency pair that is above or below the fixed price before the trade closes leads to slippage in the forex market. When you want to buy or sell a currency pair, you specify a certain price at which you want to enter or exit the market. The currency pair is sold at the most favourable price trading in the market by the broker, which is either more, less, or equal to your fixed price. If the price at which the trade takes place equals the price you specified, there is no slippage. However, if the price is more than specified during a short or sell trade, it is considered a positive slippage and vice versa. If the market price is more than the price specified during a currency pair’s purchase, it is considered a negative slippage and vice versa. When market prices of a currency pair change quickly, the possibility of slippage occurring increases. It can occur under different circumstances like a major economic news announcement, an outbreak of war, etc.
Example of slippage trading in forex
Let us assume that you are trading USD/EUR, which is currently trading at an exchange rate of 2. You place a buy order to purchase USD/EUR at 1.9. Upon the order submission, the best price available in the market for USD/EUR is 1.95. Hence, the exchange platform will execute your order to purchase USD/EUR at 1.95, resulting in a negative slippage of 0.05 since you pay more than your expected price. To understand positive slippage, let us assume that the same currency pair trading at 2 drops to 1.8. As you have fixed a market order at 1.9, your order will be executed at a better than expected rate at the market price of 1.8, resulting in a positive slippage of 0.1 since you pay less than your expected price.
What are the causes of slippage?
Change in the exchange rate
The exchange rate can change at the exact moment as you process an order due to a change in the demand or supply of the currency pair, especially during periods of high volatility. This leads to slippage as the market price deviates from the price fixed.
Lack of liquidity
When the currency pair market is not as liquid as needed at the fixed price level, the market order shifts to the next best price level to move forward with the order execution. Such an order can be executed through a market stop order or limit order. For example, if you wish to trade 100 units of USD/EUR at 2, but only 50 units are available at this price, a trade order will be executed for 50 units at the fixed price. The order for the rest of the 50 units will be executed at the next best available price.
When a currency pair in the forex market is extremely volatile, the chances of slippage increase. This is because the frequently fluctuating currency pair prices can lead to order execution at a price different from what you have set with your broker. If the currency pair prices see big moves in the market due to a particular economic or global reason, the slippage will also be higher.
When there is a major news announcement or markets close and open at significantly different price levels, a price gap takes place, which can also cause slippage. Over the weekend, any significant shift in the opening price from the previous day’s close can result in an order being executed from a level different from the set price.
Difference between buyers and sellers
When the number of buyers and sellers for a particular currency pair is not equal, the chances of slippage occurrence increase. For every buyer who has a specific price for a certain lot size, there must be the same number of sellers for the order to be executed at the same price. If there is a difference between the buyers (demand) and sellers (supply), the currency pair prices are bound to deviate and cause slippage.
Top tips to avoid slippage
1. Set a slippage tolerance level
Most forex platforms allow traders to set their slippage tolerance levels wherein they provide a percentage up to which they are ready to accept the price gap. Any price difference beyond the slippage tolerance level rejects the order altogether, and the order is not executed.
2. Place guaranteed stop-loss orders
Guaranteed stop-loss orders ensure that the trade is exited at the exact price you fix in case the market moves against your trade. This helps you protect your trade positions no matter how volatile the market is, and you do not lose more than your tolerance through slippage.
3. Shift to limit orders from market orders
You can also avoid slippage by shifting to limit orders instead of market orders. Limit orders allow you to fill the desired price, and the trade is only executed at this price level (or a better one) if the currency pair touches it. If the currency pair trades at a price worse than what you set, the limit order expires and is not executed.
4. Avoid trading around major economic announcements
Most slippage occurs when there is a positive or negative economic event ongoing. To avoid risks due to slippage, avoid trading around such situations by tracking the calendar for any global news that could affect the forex prices. Slippage can also be avoided by not trading during ongoing economic turbulence like a pandemic or war outbreak since the markets are expected to be highly volatile in such situations.
5. Trade the non-traditional hours
You can avoid slippage by trading in non-traditional hours as the market is the least volatile during these hours. Trading in the early or late hours of the day witnesses the least volatility as fewer buyers and sellers are trading the currency pairs at that time. This enables traders to execute market orders at their specified prices.
6. Trade when the market is highly liquid
Trading in a highly liquid market indicates that there are as many sellers as there are buyers. This decreases the chances of slippage and increases the chances of the orders being executed at prices fixed by the trader. When a currency pair trades with high volume, the slippage is less and order execution is more seamless.
7. Trade with high execution speed brokers
Choose a broker that offers the maximum execution speed to ensure that your orders are executed without delay. Delay in order execution leads to slippage wherein the price fixed and market price differ from each other as currency pairs have more time to fluctuate. When the broker executes an order within seconds, currency pairs have less time to fluctuate and hence, most orders are able to execute at the desired price with minimum to no slippage.
8. Check how your broker treats slippage
Some trading exchanges execute market orders even when the current price does not match the specified price under the slippage tolerance. However, most brokers only execute the trade if the currency price is under your specified slippage tolerance level. The orders are rejected if the trade falls outside your slippage tolerance level. Hence, checking how the trading platform and broker treats slippage is essential to minimise it while trading.
When to avoid slippage as a trader?
Day or short-term traders
Day or short-term traders hold several forex positions in a single trading day to make gains from small price moves. As a day trader, you should avoid trading currency pairs during scheduled news and global events like an organisation’s earnings report, trade news between two countries, employment situation summary, etc.
Swing or medium-term traders
Swing or medium-term traders hold a forex position for a few weeks or months to make gains through a particular trend in the market. As a swing trader, you should avoid trading after a major announcement has already occurred, like a war outbreak, a pandemic situation in the country, recessionary or inflationary pressures, etc.
Position or long-term traders
Position or long-term traders hold a forex position for at least one year or more to make gains from the overall market sentiment. As a position trader, you should avoid trading near the financial year’s end and other yearly news announcements like the national budget, balance of trade summary, GDP declaration, etc.
What is slippage tolerance in crypto?
Slippage tolerance in crypto refers to the maximum amount that cryptocurrency traders are willing to accept as a difference between the market order price and the actual price at the time of execution. It is set as a percentage level, and every trader can have a different slippage tolerance over and above the default slippage tolerance offered by the cryptocurrency exchange platform. For example, let us suppose that you want to trade BTC, which is currently trading at $2,500,000. You open a buy position to purchase one unit of BTC at $2,490,000 with a slippage tolerance level of 1%. This means, as a crypto trader, you are ready for the trade to be executed at a level 1% worse than the price you fixed. Now let us suppose that the BTC price increases from $2,500,000 to $2,514,900, which is 1% above your set price target to enter the long position. Since the slippage matches your slippage tolerance, the trade will be executed at the current price of $2,514,900. However, assuming the BTC price increased to $2,525,000 for one unit of the cryptocurrency, your market order would expire and not be executed as the price difference between the market order price and current market price exceeds your slippage tolerance.
Minimise price fluctuation risks with slippage
Slippage occurs when the forex market is high in volatility but low in liquidity, leading to risks associated with severe price fluctuations. Setting a slippage tolerance or boundary order enables you to fix a range between which you are ready to accept the slippage. Start trading with Blueberry Markets today to access advanced trading tools for both the forex market and CFDs. Sign up for a live trading account or try a risk-free demo account.
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