Slippage is a frequently encountered phenomenon in forex trading, although it is often not fully comprehended. It is essential for traders to grasp the mechanisms behind forex slippage, as this understanding can help minimize undesirable slippage while capitalizing on favorable slippage. In this article, we will delve into the intricacies of slippage in the forex market and provide insights into how traders can effectively reduce its negative impact.
WHAT IS SLIPPAGE?
Slippage refers to the situation when a trade is executed at a price that differs from the price specified in the trading order. It typically happens when there is significant market volatility or when there is insufficient liquidity to fulfill orders at the desired prices.
While slippage in forex trading is often viewed negatively, it can actually present favorable opportunities for traders. When trade orders are sent to liquidity providers or banks, they are executed at the most advantageous price available, regardless of whether it is higher or lower than the requested price.
To illustrate this concept, let's consider an example. Suppose we aim to purchase the EUR/USD currency pair at the current market rate of 1.3650. When the order is executed, there are three possible outcomes: no slippage, positive slippage, or negative slippage. Let's explore these outcomes in more detail.
Let's examine different scenarios that illustrate the various outcomes of forex slippage:
Outcome #1: No Slippage
In this case, when we submit the order, the best available buy price aligns perfectly with our requested price of 1.3650. Consequently, the order is filled at the exact price we specified, without any slippage.
Outcome #2: Positive Slippage
Upon order submission, the best available buy price unexpectedly shifts to 1.3640, which is 10 pips below our requested price. As a result, our order is executed at this more advantageous price of 1.3640, resulting in positive slippage.
Outcome #3: Negative Slippage
When we submit the order, the best available buy price suddenly changes to 1.3660, which is 10 pips above our requested price. Consequently, our order is filled at this higher price of 1.3660, leading to negative slippage.
These examples demonstrate the potential outcomes of slippage in forex trading, including scenarios with no slippage, positive slippage, and negative slippage.
WHAT ARE THE FACTORS THAT LEAD TO SLIPPAGE AND HOW CAN YOU PREVENT IT?
Forex slippage arises due to the fundamental dynamics of a market, which involves the interaction between buyers and sellers. For any given price and trade size, there must be an equal number of buyers and sellers. If there is an imbalance between them, prices will fluctuate.
As forex traders, when we attempt to buy a certain amount of a currency pair at a specific price, such as purchasing 100k EUR/USD at 1.3650, the execution of our order relies on finding sellers willing to exchange their Euros for US dollars at that exact price. However, if there is a scarcity of sellers at 1.3650, our order needs to explore alternative options and purchase the Euros at a higher price. This results in negative slippage.
Conversely, if there is an abundance of sellers looking to sell their Euros at the time our order is submitted, we may find a seller willing to offer them at a price lower than our initial request. This would grant us positive slippage.
Furthermore, forex slippage can also occur when normal stop loss orders cannot be executed at the specified level. However, there are "guaranteed stop losses" available, which differ from regular stop losses. Guaranteed stop losses ensure that the specified level will be honored by the broker, regardless of market circumstances. Essentially, the broker assumes any losses resulting from slippage. It's important to note that guaranteed stops often come with a premium charge if they are triggered.
WHICH CURRENCY PAIRS HAVE THE LOWEST RISK OF SLIPPAGE?
Currency pairs that exhibit high liquidity, such as the EUR/USD and USD/JPY, tend to experience less slippage under normal market conditions. However, it is important to note that even these highly liquid pairs can be susceptible to slippage during periods of market volatility, particularly before and during significant news or data releases.
When news or data events occur, they can significantly increase market volatility. To equip yourself for trading in such volatile conditions, we recommend reading our suggestions for trading the most volatile currency pairs or obtaining our newly developed forex trading guide.
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