In forex trading, slippage happens when prices fluctuate rapidly within a short span of time. It helps traders see how the prices of currency pairs have moved away from their expected prices.
Traders can set a limit on how much slippage in forex trading they can handle to protect themselves from these sudden changes. If the slippage is higher than this limit, their orders won’t go through. In our article, we will explain what slippage is and share tips on how to avoid it.
What is Slippage in Forex Market?
Slippage occurs when a currency pair order is executed at a price different from what was initially anticipated. The determination of the difference between the expected market price and the actual market price occurs when the order is executed.
This occurs more frequently when the market is highly volatile, as currency prices can fluctuate rapidly. When a large market order is made with low buying pressure, it is hard to maintain the expected price of the currency pair.
How Does Slippage Work?
If the value of a currency pair fluctuates from the predetermined price before the trade concludes, it results in slippage in the forex market. When you intend to trade a currency pair, you indicate the price at which you desire to enter or exit the market.
The broker executes the sale of the currency pair at the most advantageous price available in the market, which may be higher, lower, or equal to your specified price. If the execution price matches the price you indicated, slippage does not occur.
If the price at which you sell is higher than the predetermined price you set, it is referred to as positive slippage. If the market price goes above your set price when buying a currency pair, that’s negative slippage, and the opposite is true as well.
The chance of slippage in forex goes up when the market prices for a currency pair change quickly. This occurrence can happen under different circumstances, like major economic releases or important geopolitical events.
What are the Causes of Slippage?
1. Change in the Exchange Rate
When you’re placing an order, the exchange rate can suddenly change. This happens due to changes in demand or supply of the currency pair, especially when the market is unpredictable, which is called high volatility. When this occurs, the market price may drift away from the fixed price, causing what is known as slippage.
2. Lack of Liquidity
At times, there may not be enough currency available at the desired fixed price. When this happens, your order moves to the next best price to complete the transaction. You could utilise a market stop order or a limit order in this situation.
For instance, if you’re aiming to trade 100 units of USD/EUR at 2, but only 50 units are available at that rate, the trade will go through for those 50 units at the fixed price. The remaining 50 units will be exchanged for the next best available price.
3. Volatility
When a currency pair is very volatile, prices can change quickly. This increases the likelihood of slippage since the order might be completed at a different price than intended. If a significant economic or worldwide event causes large swings in currency prices, slippage tends to increase.
4. Price Gaps
Price gaps happen when important news is announced or when markets close and reopen at much different prices. This can also lead to slippage in forex trading. For example, if, over the weekend, the market opens at a price that is very different from the previous closing price, your order might be executed at a different rate than you planned.
5. Difference between Buyers and Sellers
When the number of buyers and sellers for a specific currency pair isn’t balanced, slippage is more likely to occur. Forex slippage occurs when the final price of a transaction is different from the expected price.
For a buyer wanting to buy a specific amount of currency at a set price, there needs to be an equal number of sellers willing to sell at that price. If buyers and sellers do not match, the prices of the currency pair can change. This imbalance leads to a change in prices, causing slippage to occur.
Top Tips to Avoid Slippage While Trading Forex
1. Set a Slippage Tolerance Level
Forex platforms allow you to decide how much price gap is acceptable during trading by setting a slippage tolerance level, expressed as a percentage. If the price changes beyond this percentage, the trade will not happen.
2. Place Guaranteed Stop-Loss Orders
Use guaranteed stop-loss orders to safeguard your trades. These orders close your trade automatically at the exact price you decide if the market starts to move against you.
3. Shift to Limit Orders from Market Orders
To avoid slippage in forex trading, prefer the usage of limit orders instead of market orders. Limit orders will only go through if the currency reaches the price you set or a better one. If the price isn’t favourable, the order doesn’t happen.
4. Avoid Trading Around Major Economic Announcements
Slippage is common during significant economic events that impact forex prices. To minimize this risk, steer clear of trading during these times by keeping track of economic news on a calendar. Also, avoid trading during global crises, such as pandemics or wars due to market instability.
5. Trade during Non-Traditional Hours
Trading when the market is less busy can reduce the chance of slippage in forex trading. In the early morning or late evening, the market has less activity, meaning fewer buyers and sellers. This stability allows traders to secure trades at their preferred prices.
6. Trade in an active market
When the market is very active, there are equal numbers of buyers and sellers, making it easier to trade smoothly. This situation reduces the likelihood of unexpected changes in the price, known as slippage. In such conditions, your trades are more likely to be completed at the prices you set, as active markets help keep prices stable and predictable.
7. Choose brokers with fast execution
It’s important to select a trustworthy forex broker that can process your trades quickly. This speed is crucial because fast execution minimises the chances of price changes that could negatively affect your trade. With quick execution, the price is more likely to stay the same between the time you decide to trade and when it happens, ensuring you get the price you want.
8. Know your broker’s approach to slippage
Slippage happens when the execution price of your trade differs from the price you specified. Some platforms will still complete your trade if the price difference is within a certain limit you set.
However, many brokers will not execute a trade if the price difference is too large. It’s crucial to understand how your broker handles such situations. By knowing this, you can better manage your trades and reduce the chances of slippage, ensuring that your orders are completed at prices favourable to you.
When to Avoid Slippage as a Trader?
1. Day or Short-Term Traders focus on managing multiple forex positions within a single trading day. They seek to make money from even tiny price shifts. If you’re involved in day trading, it’s important to steer clear of trading currency pairs when major news is expected to come out. These might be events like company earnings reports, trade negotiations between countries, or key employment data releases.
2. Swing or medium-term traders typically hold a position in forex for weeks or even months. Their goal is to capitalise on specific market trends. If you choose to swing trade, you should be cautious after big announcements. For instance, if there is news about a war starting, a pandemic outbreak, or economic problems like recession or inflation, it might be wise to hold back from trading.
3. Long-term traders hold their forex positions for a year or more, aiming to profit from the general market sentiment. Position traders should avoid engaging in trades toward the end of the financial year or following significant yearly news announcements. This can include occasions such as the release of the national budget, summaries of the trade balance, or announcements about the GDP.
What is Slippage Tolerance?
Slippage tolerance is a feature on trading platforms. It lets you choose how much price change you can accept for your order to be completed.
If prices change and you don’t set a slippage tolerance, your broker will choose the next available market price. Setting a slippage tolerance allows you to manage the price difference, helping you reduce risk.
Minimise price fluctuation risks with slippage
Slippage happens in the forex market when there is high volatility coupled with low liquidity, resulting in risks from significant price changes. By establishing a slippage tolerance or boundary order, you can define a specific range within which you are willing to accept slippage.
Conclusion
Slippage in forex trading is an essential part of trading that every trader must understand and manage well. By identifying the elements that lead to slippage and adopting strategies to lessen its effects, traders can enhance their performance and reduce possible negative consequences.
Being aware of market conditions, selecting the right order types, and partnering with a trustworthy broker are essential measures for managing slippage and improving overall trading results.