Slippage on a trade can be quite significant, so it’s important to educate yourself about the concept to avoid any surprises. So, what is slippage and why does it occur?
- What is slippage?
- Examples of slippage
- Why does slippage occur?
- When does slippage occur?
- Is slippage very costly?
- How to avoid slippage
1. What is slippage?
Slippage is when the price of a market when opening or closing a trade is different to what was expected. It is a natural occurrence and is very likely to happen at some point in time to your trades. Although it’s often considered bad, slippage doesn’t always have a negative effect on your trades.
There are three types of slippage in trading. The first is positive slippage, which is where a price is opened or closed at a level that is better than what was expected in the eyes of the trader. For instance, when a trade is opened, the price will be less than what the trader intended to open at, offering more value.
As the name suggests, no slippage is where the price of a market was opened or closed at the intended, expected and exact price. This is the most common form of slippage, as the majority of trades will be executed at their intended price. However, ‘no slippage’ is not a term that is frequently used to refer to these trades as this is simply the norm.
A final form of slippage is negative slippage. This is where the trader loses value, as the executed price is worse than the expected price.
2.Examples of slippage
Example 1 (Negative slippage while opening a trade)
A trader intends to trade Amazon at a price of 100.00 and clicks to open a long position at this price. When the trade is executed, though, the price ‘slips’ and the position is opened for Amazon at the 101.00, the new price it rose to.
Example 2 (Negative slippage while closing a trade)
A trader is looking to sell Facebook at a price of 100.00 and clicks to close his open position. The price at the time of execution when the trade is closed falls to 99.00 though, so in this case the trader has lost out by one point of value.
Example 3 (Positive slippage while opening a trade)
A trader is looking to buy Gold at a price of 250.00. As the position is opened, the executed price is 240.00, meaning the trader has opened a position at 10 points less than intended for the same trade.
Example 4 (Positive slippage when closing a trade)
A trader intends to trade Apple, closing their position at a price of 250.00. The executed price that the position is closed at though, is 275.00, meaning the trader has benefited from the slippage to the tune of 25 points.
Example 5 (No slippage when opening a trade)
A trader intends to open a long position on Facebook and clicks to buy at a price of 200.00. The trade is executed at 200.00, meaning no value has been lost or gain from the expected price.
3. Why does slippage occur?
Slippage happens when there is not equilibrium between the buy and sell orders in a market. For instance, if a buy order is set for Facebook at a price of 100.00, but the only price of sell orders at the time is 95.00, the buy order will adjust to the nearest possible price it can be ‘matched’ with.
Of course, this means that you could be losing out on multiple points of value compared to the expected price, but often you can set how much differentiation you want to allow between the expected price of a market and the executed price.
Slippage also happens when the time it takes for a broker to place or execute the trade is not instant. A few brokers, ETX Capital for one, offer instant execution with trades, but for all brokers it depends on connectivity and the capabilities of the trading platform as to whether instant execution can be offered.
For instance, a position might be intended to be opened at a price of 100.00, but in the time it takes for the broker to connect with the exchange and execute the trade, this price will have changed and thus the execution price will vary from the intended price.
4. When does slippage occur?
In reality, slippage can occur at any time. It is unpredictable and could affect almost all trades regardless of broker, time of the day, type of trade etc. However, slippage is more common in certain circumstances.
During times of high volatility, slippage is most common. This is because market prices are moving and changing quickly, so it is much more difficult for one person’s sell price to be equal to another person’s buy price.
At times of volatility, if a price is rising, it’s more likely to continue rising higher than at quieter times. Equally, if it’s falling, it’s more likely to keep falling. For this reason, orders are set further from the actual price at any one moment in anticipation, causing this slippage. For instance, if you want to open a short position on a volatile market at a price of 1000.00, but you see it has risen 100 points in the last hour, you’ll set an order at a higher price. This could be 1050.00, as you anticipate that the volatility will keep the price rallying and thus you’ll get better value to open your sell position.
During periods of high volatility, slippage may also be common if trades aren’t executed instantly. If a broker takes even one second to open a position for their clients, prices will change with the most volatile markets. Look at one of the main markets and count how long it stays on exactly the same price for. It will rarely be longer than a few seconds, so brokers must match this fluctuation by executing trades instantly, or else risk being affected by slippage.
Slippage also occurs in markets with low liquidity. This is where there is little trading activity in the market. The market could be highly volatile, but only a handful of people are actually trading it. Due to the lack of demand in that market, be it long or short, there is consequently fewer orders to match together to confirm an equal price, so slippage occurs.
5. Is slippage very costly?
All in all, you shouldn’t be too worried about slippage. When it does occur, it’s often for very insignificant values – a change of one or two points for a £5-a-point position is not going to have too much impact on your PnL overall.
Also, as established slippage is not always something that negatively impact the trader. Positive slippage occurs frequently so it’s swings and roundabouts in terms of losing and gaining value from slippage.
The only time where it could be costly is when trading illiquid and unpopular markets where there are low volumes of trades. With fewer trades, it’s tougher for people’s buy and sell orders to be matched. Therefore, it’s tougher for orders to get executed at the intended price. Trades will often be opened at the closest possible price to what the order stated, but with few trades this can often be a significant points variance.
6. How to avoid slippage
We’ve established that slippage is not all bad, but it still might be something to avoid. Stops and limits are forms of risk management tools that can be implemented to help negate the effect of slippage.
Guaranteed stops, different from regular stops, are ways to secure the exact price you want regardless of slippage, gapping or any other factor that would usually cause your executed price to vary from the intended price. This is because the broker takes on the risk of the price changing to guarantee you the price you want, so if you’re looking to close an open position, guaranteed stops are very effective. These usually come at a premium, but we offer free guaranteed stops for all standard clients on certain markets.
Limits can also be useful as they ensure a buy order is not executed at a level that is significantly above the intended buy price.