What is Slippage?

Slippage refers to the difference between the expected price of a trade and the actual price at which the trade is executed. Slippage typically occurs when the market price moves quickly or in environments with low liquidity. It happens when there is a change in the market price between placing an order and its execution.

Key characteristics of slippage include:

• Price Difference: Slippage is the gap between the expected price and the actual execution price. For example, if you expected to buy at 1.1500 but due to market fluctuations the execution price was 1.1520, the slippage would be 20 pips.

• Causes:

  • Market Volatility: Slippage is more likely during times of significant market volatility, such as the release of important economic data, news events, or at market open/close.

  • Low Liquidity: In markets with lower liquidity, the bid-ask spread is larger, which can cause slippage. Stocks or currency pairs with lower trading volume are more likely to experience slippage.

  • High-Frequency Trading: In high-frequency trading environments, a large number of orders can cause rapid price changes, increasing the risk of slippage.

• Types of Slippage:

  • Positive Slippage: When the actual execution price is better than expected. For example, if you expected to buy at 1.1500 but the execution price is 1.1480, you benefit from positive slippage.

  • Negative Slippage: When the actual execution price is worse than expected. For example, if you expected to buy at 1.1500 but the execution price is 1.1520, you experience negative slippage.

• Impact: Slippage directly affects the cost and profitability of trades. It can increase transaction costs or, when prices move unfavorably, reduce profits or increase losses.

Strategies to Reduce Slippage:

• Use Limit Orders: Limit orders set a specific price at which the trade will be executed, only triggering the trade if the price is met or improved, thus avoiding slippage.

• Choose High Liquidity Markets: Markets with higher liquidity (such as major currency pairs or large-cap stocks) usually experience less slippage.

• Choose the Right Trading Time: Avoid trading during periods of high volatility (e.g., major economic data releases) to reduce the risk of slippage.

Slippage is a common phenomenon in financial markets, and understanding its causes and impacts can help traders better manage their trading risks.