Thadeus Geodfrey
Slippage is a term often heard by traders, especially beginners, but what does it actually mean? In simple terms, slippage refers to the difference between the price you expect to pay (or receive) for a trade and the price at which it is actually executed. This can happen across various markets, such as stocks, forex, or ETFs, and occurs when there is a delay between the time you place your order and when it is filled.
Although slippage is not always a negative occurrence, it can be frustrating when you’re aiming for a specific price. Understanding its causes and how to minimise it is essential for traders seeking to avoid unexpected costs in their trading strategy.
What is Slippage?
Slippage occurs when a trade is executed at a price different from the one you initially saw when placing the order. Let’s say you want to buy a stock at £100 per share, but by the time the order is processed, the price rises to £101. The £1 difference is the slippage.
Slippage often happens during periods of high volatility, but it can also occur at any time, especially when you’re trading large volumes or when market liquidity is low.
In the case of forex, slippage tends to occur when currency prices change rapidly, such as around economic announcements. For ETFs, slippage can happen when there’s a significant gap between the buy and sell prices.
Slippage in Different Markets
- Stock Slippage: This typically happens when there’s a large order or low liquidity in the stock you’re trading. If there aren’t enough buyers or sellers at your expected price, your order might get filled at a worse price.
- Forex Slippage: Forex markets are highly volatile, which makes slippage more common. A trader might intend to buy the Euro at 1.2000, but due to a sudden price shift, the order gets filled at 1.2005.
- ETF Slippage: Slippage can also occur in ETF markets, particularly when the price of the ETF deviates from the expected price during trade execution. This can be influenced by fluctuations in the market or differences between the bid and ask prices.
Causes of Slippage
Slippage doesn’t just happen randomly. There are several factors that contribute to it, and understanding these causes can help you reduce its impact.
Market Volatility
The main cause of slippage is market volatility. During volatile periods, the price of an asset can move quickly, making it harder for your order to be executed at the price you want. Economic reports, major news events, or sudden changes in market sentiment can cause large price swings, leading to slippage.
Low Liquidity
Liquidity refers to how easily an asset can be bought or sold without affecting its price. When liquidity is low, such as during off-hours or in markets with less activity, your trade may not be filled at the expected price. This is more likely to happen with less-traded assets or those with low trading volume.
Order Type
Certain order types are more susceptible to slippage. Market orders, for instance, are executed immediately at the best available price. If the price moves before the order is filled, slippage occurs. On the other hand, limit orders let you specify a price, but they may not always get filled if the price moves away from your target.
Large Orders
If you’re placing a large order relative to the volume available in the market, slippage is more likely. Your order might be filled at multiple price points, particularly in markets with lower liquidity.
How Can I Avoid Slippage in Trading?
While slippage is a part of trading, there are ways to reduce its chances and mitigate its impact.
Using a limit order is one of the best ways to avoid slippage. A limit order allows you to specify the maximum price you are willing to pay when buying, or the minimum price you want when selling. If the price moves beyond your limit, the order won’t be executed, preventing you from paying more than you planned.
Markets are more liquid during peak trading hours. For example, forex markets see higher liquidity when major trading centres like London and New York are open. This reduces the chances of slippage, as there are more buyers and sellers at any given time.
Before placing a trade, it’s important to monitor market conditions. High volatility increases the likelihood of slippage, especially during significant economic events. If you’re trading in such conditions, consider using limit orders to protect yourself from price swings.
Try to avoid placing large orders that can affect the market price, particularly in markets with lower liquidity. Instead, break your large order into smaller parts to avoid triggering slippage.
When to Watch Out for Slippage
Certain conditions make slippage more likely, and recognising these situations can help you better manage the risks.
Economic Announcements
Economic data releases, such as GDP reports or interest rate decisions, can lead to significant price changes. If you place an order around these events, slippage may occur due to the rapid movement of prices.
After Market Hours
Slippage often increases once markets close, as trading thins out and prices tend to jump between levels. If you’re placing orders outside core hours, it’s worth checking the typical UK stock market hours so you have a clearer sense of when liquidity is strongest and when slippage is more likely.
During High Impact News Events
Geopolitical events, financial crises, or major natural disasters can trigger sudden shifts in supply and demand, resulting in sharp price movements and slippage. Staying informed about global news is crucial if you’re trading around such events.
Low Liquidity Markets
In markets with lower liquidity, such as stocks that aren’t heavily traded, slippage becomes more common. Always check the volume of an asset before placing a trade to avoid slippage in these markets.
How Slippage Affects Trading Strategies
Slippage can significantly impact your trading strategy, whether you’re a day trader, swing trader, or long-term investor. It may lead to unexpected costs and missed opportunities. Here’s how slippage can affect your strategy and how to manage it.
1. Impact on Entry and Exit Points
Slippage can disrupt your entry and exit points. For instance, a day trader aiming to buy a stock at £50 may see the price rise to £51 by the time the order is filled, affecting the risk-to-reward ratio. Similarly, slippage could cause your stop-loss or take-profit orders to be filled at worse prices, leading to unintended results.
This is especially problematic for strategies relying on precise timing, like scalping, where small price shifts can significantly alter outcomes.
2. Increased Trading Costs for Frequent Traders
For traders making frequent trades, slippage adds up over time, eating into profits. While a single instance may seem minor, repeated slippage can become a hidden cost, particularly for strategies targeting small, incremental gains. In volatile markets, the cumulative cost can be substantial.
3. Risk of Overtrading
Some traders overtrade in an attempt to compensate for losses from slippage. This can lead to higher costs, more errors, and even more slippage. To manage this, it’s important to stick to your strategy and avoid overtrading, which only increases risk.
4. Impact on Long-Term Strategies
Long-term investors might not be as affected by slippage, but it can still influence large orders or trades in illiquid markets. While its impact may not be immediate, slippage can affect the average cost of investments, especially in ETFs or less-liquid stocks.
FAQs
Slippage in forex often happens more frequently due to the constant price fluctuations and the 24-hour nature of currency trading. Stock slippage also occurs, but it is usually linked to market hours and liquidity levels.
It is not possible to avoid slippage entirely, but it can be reduced by using limit orders, trading during peak market hours, and avoiding large trades in markets with low liquidity.
Volatile markets, such as during economic releases or major news events, can cause rapid price movements. These swift changes in price increase the likelihood of slippage, as there may not be enough liquidity at the expected price.
Slippage affects traders differently depending on the types of orders they place, the size of their trades, and the markets they trade in. Beginners might experience more slippage if they are unfamiliar with order types or trade in illiquid markets.
Final Thoughts
Slippage is a normal part of trading, but understanding its causes and how to minimise its impact is crucial. Whether you’re trading stocks, forex, or ETFs, managing slippage involves being aware of market conditions, using the right order types, and avoiding large trades in illiquid markets. While it may not be entirely avoidable, staying informed and using strategic tools can help you navigate slippage with more control.
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