What is slippage in trading and what can I do to avoid it?

Key takeaways:

• Slippage Definition: Slippage occurs when there is a difference between the expected price and the actual execution price of a trade, often due to market volatility or liquidity issues.
• Factors Contributing to Slippage: Key factors include market volatility, liquidity, order execution delays and high-frequency trading.
• Minimising Slippage: Strategies to reduce slippage include using limit orders, trading during high-liquidity periods, avoiding high volatility times, and choosing a reputable broker.
• Impact on Orders: Slippage affects different types of orders differently, with market orders being the most susceptible, and limit orders providing more control.
• Market Variance: Slippage levels vary across markets, with low liquidity and high volatility. Emerging markets generally experience more slippage.
• Broker Influence: A broker’s execution speed significantly impacts slippage, with faster execution helping to minimise its effects.

What is slippage in trading?

Slippage in trading refers to the occurrence where there is a difference between the price at which a trade was intended to be executed and the price at which the trade is executed. This discrepancy arises due to delays between the order being placed and its execution. During this delay, the market price may have shifted, resulting in a trade being completed at a different price than initially expected.

Why does slippage happen?

Several factors contribute to the occurrence of slippage:

• Market Volatility: Slippage often occurs during periods of high market volatility, when rapid and unpredictable price movements can occur. Major news events, significant economic reports, or geopolitical developments can trigger such volatility. During these times, the market can move quickly, causing the execution price of a trade to differ from the expected price due to rapid changes in supply and demand.
• Liquidity: A market's liquidity plays a crucial role in the degree of slippage experienced. Low liquidity markets, with fewer participants and limited trading volumes, can lead to larger price fluctuations. In such markets, the bid-ask spread—the difference between the price buyers are willing to pay and the price sellers are willing to accept—can widen, causing trades to be executed at less favourable prices.
• Order Execution Delays: Slippage can occur when there are delays in order execution. If there is a lag between placing and executing an order, the market price might have changed during this interval. Such delays can result in the trade being executed at a price different from the one at which it was initially intended.
• High-Frequency Trading: The presence of high-frequency trading and algorithmic trading can influence slippage. These types of trading involve rapid, automated transactions and can affect market liquidity and price stability. In markets with high-frequency trading, price movements can be more pronounced, leading to increased slippage, especially when there is rapid buying or selling activity.

When is slippage most likely to occur?

Slippage is more likely to occur under specific market conditions, including:

• High Volatility Periods: Slippage tends to be more pronounced during periods of heightened market volatility. This can include times of significant economic announcements, major geopolitical events, or market open and close periods. The market reacts strongly to new information during these times, leading to rapid price changes and increased slippage.
• Low Liquidity Conditions: Markets with low liquidity, such as certain small-cap stocks or less actively traded forex pairs, are more prone to slippage. Low liquidity often results in wider bid-ask spreads and fewer buyers and sellers, making executing trades at desired prices more challenging and leading to more significant slippage.
• News Releases: Major news releases, such as earnings reports, economic data, or geopolitical developments, can cause sharp price movements. The immediate reaction to such news can lead to increased volatility and a higher likelihood of slippage as the market adjusts to the new information.
• Market Open and Close: The beginning and end of trading sessions often experience increased volatility and slippage. At these times, markets react to overnight developments and new information, which can cause prices to move rapidly and lead to slippage.

How can I minimise slippage?

Minimising slippage involves implementing strategies to manage its impact effectively:

• Use Limit Orders: Unlike market orders, which are executed at the best available price, limit orders specify the price you are willing to buy or sell. By setting a limit order, you can ensure that the trade is only executed at your specified price or better, reducing the risk of slippage. However, it's important to note that limit orders may not always be filled if the market price does not reach the specified level.
• Trade During High Liquidity Periods: Executing trades during times of high liquidity can help reduce slippage. High liquidity typically occurs during major market hours when trading volumes are higher. During these times, the bid-ask spread tends to be narrower, and there are more buyers and sellers, which can help ensure trades are executed at prices closer to the expected level.
• Avoid High Volatility Times: Be cautious when trading during periods of high volatility. This includes avoiding trades during major news releases or other events leading to rapid price changes. By choosing to trade during more stable periods, you can minimise the impact of slippage.
• Choose a Reputable Broker: Selecting a broker with a strong reputation for fast and reliable order execution can help mitigate the risk of slippage. Brokers with efficient execution speeds are better equipped to execute trades at or close to the expected price, reducing the likelihood of slippage.

Does slippage affect all types of orders?

Slippage can impact various types of orders, though its effect can vary:

• Market Orders: Market orders are particularly vulnerable to slippage because they are executed at the best available price at the time of execution. During volatile conditions or low liquidity periods, the price at which the order is executed can differ significantly from the expected price.
• Limit Orders: Limit orders can help manage slippage by specifying the exact price at which a trade should be executed. While this can reduce the risk of slippage, there is a possibility that limit orders may not be filled if the market price does not reach the specified level. This means the order might remain unexecuted if the price does not match the limit.
• Stop Orders: Stop orders, which convert into market orders once a certain price level is reached, can also experience slippage. If the market moves rapidly after the stop level is triggered, the order may be executed at a price significantly different from the stop level, resulting in slippage.

How much slippage is considered normal?

The extent of normal slippage can vary based on market conditions and asset class:

• Minor Slippage: In most markets, slippage of a few pips (for forex) or cents (for equities) is typical and may be considered normal. This minor slippage is generally manageable and is often accepted as part of the trading process.
• Significant Slippage: Excessive slippage, especially when it significantly impacts trading costs or overall profitability, may indicate underlying issues such as low liquidity or high volatility. Traders should know these factors and adjust their strategies to manage significant slippage.
• Contextual Variance: The acceptability of slippage depends on the trader’s strategy and the specific market conditions. Traders should evaluate slippage in the context of their overall trading approach and objectives to determine whether the level of slippage is acceptable.

Is slippage always negative?

Slippage is not always negative:

• Positive Slippage: In some instances, slippage can result in a more favourable outcome. For example, a market order executed during a downward price trend might be completed at a lower price than anticipated, which could benefit the trader.
• Negative Slippage: More commonly, slippage results in a less favourable price, leading to increased trading costs or reduced profitability. This negative slippage can affect the effectiveness of a trading strategy and should be considered when assessing overall performance.

How does slippage impact my trading performance?

Slippage can affect trading performance in several key ways:

• Increased Trading Costs: Slippage can increase the effective cost of trading, which may reduce overall profitability. Traders should factor in slippage when calculating their trading costs and evaluating its impact on their performance.
• Performance Evaluation: Frequent or significant slippage can impact the assessment of trading strategies. Traders should consider slippage when analysing trade outcomes and refining their strategy to better manage its effects.
• Risk Management: Implementing effective risk management strategies can help mitigate the impact of slippage. By considering slippage in trade planning and execution, traders can improve their overall trading performance and better manage potential risks.

Are some markets more prone to slippage than others?

Indeed, some markets are more prone to slippage:

• Low Liquidity Markets: Markets with low liquidity, such as specific forex pairs or small-cap stocks, are more susceptible to slippage. The wider bid-ask spreads and fewer market participants in these markets can lead to more significant price deviations.
• Volatile Markets: Markets experiencing high volatility, such as during major news events or economic announcements, can exhibit increased slippage due to rapid and unpredictable price movements. Traders should be cautious during such times to manage slippage effectively.
• Emerging Markets: Emerging markets or those with lower trading volumes may experience higher levels of slippage compared to more established and liquid markets. These markets may have lower liquidity and higher volatility, contributing to more significant slippage.

Can my broker’s execution speed affect slippage?

Yes, the execution speed of your broker can significantly impact slippage:

• Fast Execution: Brokers with quick and reliable order execution speeds are better equipped to minimise slippage. Efficient execution ensures that trades are completed at or near the expected price, reducing the likelihood of slippage.
• Execution Delays: Brokers with slower execution times may experience higher levels of slippage due to greater delays between order placement and execution. This can result in trades being executed at less favourable prices, impacting overall trading performance.
• Broker Selection: Choosing a reputable broker known for its efficient order execution can help reduce slippage and enhance overall trading quality. Brokers with a strong track record in execution speed and reliability will likely provide a better trading experience with minimised slippage.

If you’d like to learn about the key steps to choosing the best CFD broker, check out Pepperstone’s guide.

Conclusion

Slippage is an inherent aspect of trading that traders must understand and manage effectively. By recognising the factors contributing to slippage and implementing strategies to mitigate its impact, traders can improve their trading performance and minimise potential adverse effects. Staying informed about market conditions, using appropriate order types, and choosing a reputable broker are crucial steps in managing slippage and enhancing overall trading outcomes.

FAQs

Can slippage be beneficial in any situation?

Yes, slippage can sometimes be beneficial. For instance, if a market order is executed at a better price than expected due to a rapid price movement in your favour, this is known as positive slippage. This can result in a more favourable trade outcome for the trader.

How does slippage affect long-term trading strategies?

Slippage can impact long-term trading strategies by increasing trading costs and affecting overall profitability. Frequent or significant slippage can erode returns over time, so long-term traders must account for slippage when developing and refining their strategies.

Are there specific trading platforms better equipped to handle slippage?

Some trading platforms are better equipped to handle slippage due to their advanced order execution technology and real-time data processing capabilities. Platforms with high-speed execution and robust infrastructure are generally better at minimising slippage.

How can traders assess the impact of slippage on their trading performance?

Traders can evaluate the effect of slippage by analysing trade outcomes and comparing the expected versus actual execution prices. Reviewing trade performance, incorporating slippage costs into overall trading costs, and adjusting strategies based on slippage patterns help understand its impact on performance.