The concept of slippage and its impact

What is Slippage?

First, let's define slippage. Simply put, slippage occurs in a trade when there's a difference between the execution price you've set, whether for a market order or a pending order, and the actual executed price.

For instance, if a client sees a quote for the EUR/USD pair at 1.2000 on the platform and the market can accept a trading volume of 5 million USD at this price, what happens if the client places an order for 6 million USD? In that case, 5 million USD will be executed at 1.2000, and the remaining 1 million USD will be executed at the next price, which might be 1.2001 or higher.

Causes of Slippage

1. Market price gaps: The example above actually illustrates slippage caused by market price gaps. Under normal circumstances, with sufficient liquidity, the market's quotes are continuous. However, during times of significant fluctuation or when large transactions occur, price gaps can appear.

2. Network latency: Generally, in forex trading, banks provide quotes to brokers, who in turn offer them to clients. When clients transact, the trading instructions reach the broker's server, are then forwarded to the bank's system, and executed there. During this transmission, there's often a slight delay. This might not be noticeable under normal conditions, but during volatile market moments, if the server can't keep up, delays can occur, leading to slippage.

Common Instances of Slippage

1. During events like the Non-Farm Payrolls, which cause significant market fluctuations, many market makers become particularly cautious. At such times, many adopt strategies like not quoting or widening the spread, which is why many trading platforms restrict trading before and after the release of Non-Farm Payroll data.

2. In the forex market, the slippage experienced on different platforms varies, mainly because different market makers offer different quotes. It's crucial to be mindful of this risk during times of sharp price movements, such as the night of Non-Farm Payrolls.

3. Slippage occurs more readily in thin markets, where lower liquidity can exaggerate market movements, leading to wider slippage. Major forex currency pairs generally have ample liquidity, effectively reducing the occurrence of slippage. Trading major currency pairs during London and New York market hours usually means more liquidity and less slippage.

4. Normal market slippage includes both positive and negative slippage, with the chances of each occurring being roughly 50%.

Typically, traders set stop losses to mitigate their risk. In such cases, once the price is hit, the broker will buy or sell at the current market price, which may be higher or lower than the client's stop loss price. Here, clients may experience both positive and negative slippage.

Situations Where Positive Slippage Occurs:

Stop Orders: All stop orders are executed at the market price in a VWAP (Volume Weighted Average Price) manner. If the final price is better than your set stop loss price, this is known as positive slippage.

Limit Orders: Limit orders are executed at your specified price or better. In such cases, you receive positive slippage. This also includes take profit orders, where the order is executed as a limit order when the market reaches the "take profit price".