What is slippage in forex trading? Why does slippage occur, and how can we avoid it?
In forex trading, a common issue we encounter is slippage. However, many people may not understand it and think that slippage is a trick played by the platform, but this is not the case. Such tricks may occur in counterparty transactions,
but in the real market, there are no such tricks. Slippage is a normal phenomenon that is inevitable.
Today, let's delve into the reasons behind slippage and strategies to avoid it, so you can minimize unnecessary losses due to slippage in your future trades.
1.What is Slippage?
In forex trading, slippage occurs when, due to instantaneous dramatic market movements or liquidity issues, a trader's order cannot be executed at the expected price, causing the trading cost to increase or the profit (or loss) to rise or fall. This is what we refer to as slippage.
The extent of slippage is most directly related to market liquidity at the time.
In highly liquid markets, slippage is almost negligible because there are enough buyers and sellers to efficiently match orders; conversely, in low liquidity environments, slippage can be more pronounced and frequent, especially for large market orders.
Slippage can be positive or negative;
If you set a take profit of 50 points and ended up with a profit of 80 points, that is positive slippage.
If you set a stop loss of 50 points but ended up stopping at 80 points, that is negative slippage.
We all like positive slippage, but what we are really concerned about is negative slippage.
Let's look at a real order: on the evening of April 10th, super data on US CPI was released, creating huge market fluctuations, with GBPUSD plummeting nearly 70 points
Due to the instantaneous fluctuation in prices, a client's long position was stopped out, resulting in 40 points of negative slippage.
This is a very typical example of negative slippage.
Slippage in the real market is inevitable, and there are many reasons behind its occurrence. Let's look into this further.
2.Reasons for Slippage:
1) Reduced Liquidity
"Liquidity is everything," higher liquidity means there are ample buyers and sellers, smaller market spreads, and high execution efficiency of orders that can be executed rapidly at prices close to the quotes. (This is because a large number of market participants are willing to trade at any given moment, reducing the likelihood of prices slipping.)
On the other hand, lower liquidity means fewer market participants and limited trading volume, leading to wider spreads, slippage, or execution delays, ultimately increasing costs, decreasing profits, or exacerbating losses.
2) Instantaneous Increase in Price Volatility
The publication of significant data often causes a rapid market response, with prices potentially rising or falling sharply in an extremely short timeframe. In these situations, even a millisecond difference can cause the actual transaction price to vary significantly from the expected price.
For instance, the trading mechanism of commonly used trading software such as MT4/MT5:
Quoting banks —> Liquidity providers/matching servers —> Data centers —> Bridges —> MT4 servers —> MT4 clients
Therefore, trading on the MT4 client is subject to limitations in the number of times MT4 accepts quotes, and your trade order corresponds to the price about 0.2s later, during which the market may experience widened spreads and rapidly fluctuating prices.
3) Market Price Gaps In volatile market conditions, quote gaps may occur, where there is a gap between consecutive quotes, as was the case with the aforementioned GBPUSD order.
In such cases, even if a trader places an order at one price, the execution may jump to a completely different price level by the time of execution.
4) Network Delay
Due to network issues or problems with the trader's own equipment, there may be delays in the transmission of trade instructions from the trader to the broker's server, and then to the banking system for execution.
For example, the order execution structure under MT4 is:
There can be a delay of 0.2 seconds during this period, which can result in the actual transaction price being different from the expected price in times of severe market fluctuations.
3.How to Avoid Slippage?
1) Choose brokers with excellent liquidity/trading environments
Choosing a good broker is fundamental; more quoting banks and market liquidity can significantly reduce slippage.
In this regard, choices like CWG Markets are good because CWG connects with multiple institutional accounts offering zero-spread liquidity and direct API connections to exchanges, with servers in Hong Kong and London to minimize latency issues.
2) Trade liquid instruments
Instruments with high trading volume and active buying and selling have strong liquidity, reducing the occurrence of price gaps, and effectively lowering slippage.
For example, EURUSD, GBPUSD, USDJPY, XAUUSD, etc.
In terms of instrument liquidity:
Forex>CFD>Gold & Silver >Oil
3) Avoid trading at special times
Market open and close times, moments of significant data release (like interest rate decisions, Fed chair speeches, CPI, unemployment benefits, nonfarm payroll data, etc.), on the eve of holidays, or during major international events and news can all lead to rapid market fluctuations and scarce liquidity.
Try to reduce positions or clear positions in advance as much as possible to avoid unnecessary losses.
4) Use limit orders
Consider using limit orders to specify the desired entry or exit prices, rather than executing market orders.
By setting price limits, traders can control the execution price of CFD trades and reduce the risk of slippage, especially in volatile or illiquid markets.
5) Monitor market depth
Use market depth indicators to assess the liquidity and trading activity level of the market. Understanding the dynamics of the order book can help traders anticipate potential slippage and adjust their trading strategies accordingly.
(LMAX order book)
6) Reduce network latency.
Improve your computer's configuration and enhance your network speed, and find the quickest route to connect to the trading server to reduce network latency.
For more related knowledge, please contact CWG investment advisor Ah Hai via WeChat
