How To Effectively Cope With Forex Order Slippage

Forex slippage can significantly impact your trading outcomes. This comprehensive guide explores the causes of forex slippage, its effects on your trades, and provides practical strategies to cope with this common trading challenge.

Understanding Forex Slippage

Forex slippage occurs when the executed price of a trade differs from the expected price. This scenario is particularly common in the fast-paced forex market, where prices can change rapidly.

Slippage most often occurs during periods of high market volatility when market conditions are such that orders cannot be executed at the price quoted. When this happens, your order will be filled at the next available price, which may be higher or lower than you had anticipated.

Types of Forex Slippage

• Positive slippage: When the executed price is better than expected
• Negative slippage: When the executed price is worse than expected

Understanding how forex slippage occurs can enable a trader to minimise negative slippage, while potentially maximising positive slippage.

Further reading: How does GDP affect Forex

Impacts of Forex Slippage on Trading

• Unexpected costs or gains
• Deviation from planned entry and exit points
• Potential triggering of stop-loss orders

Forex slippage can have significant effects on your trading outcomes. Understanding these impacts is crucial for developing effective coping strategies:

1. Unexpected Costs or Gains

Slippage can result in trades being executed at prices different from what you anticipated, leading to:

•  Higher costs on buy orders: You may end up paying more than expected for a currency pair.
• Lower profits on sell orders: Your sell order might be filled at a lower price than planned.
• Occasional benefits: In cases of positive slippage, you might enter a position at a more favourable price.

Example: “You place a buy order for EUR/USD at 1.2000, but due to slippage, it executes at 1.2005. This 5-pip difference represents an unexpected cost that eats into your potential profit.”

2. Deviation from Planned Entry and Exit Points

Slippage can disrupt your carefully planned trading strategy by:

• Altering your risk-reward ratio: Your actual entry point may change the potential profit or loss of a trade.
• Impacting technical analysis: Slippage might cause you to enter a trade at a less optimal point based on your chart analysis.
• Affecting overall trading system performance: Consistent slippage can skew your back testing results and live trading outcomes.

3. Potential Triggering of Stop-Loss Orders

Slippage can have a significant impact on your risk management:

• Premature triggering: In volatile markets, slippage might cause your stop-loss to trigger earlier than expected.
• Execution beyond stop-loss level: In extreme cases, your stop-loss might be executed at a price worse than specified, leading to larger losses.
• Psychological impact: Frequent slippage on stop-losses can lead to doubt and hesitation in placing necessary risk management orders.

4. Increased Trading Costs

While not always considered, slippage effectively increases your trading costs:

• Higher spreads: The difference between expected and executed prices acts as an additional spread.
• Impact on scalping strategies: For traders making numerous small trades, even minor slippage can significantly erode profits.

5. Opportunity Costs

Slippage can also result in missed trading opportunities:

• Failure to enter trades: If you use limit orders to avoid slippage, you might miss entries when the market moves quickly.
• Missed profit targets: Slippage on exit orders might prevent you from hitting your full profit target.

Understanding these impacts underscores the importance of developing strategies to cope with forex slippage effectively. By anticipating and preparing for these effects, traders can make more informed decisions and adjust their strategies to mitigate the negative impacts of slippage.

Effective Strategies to Cope with Forex Slippage

When slippage occurs, it is usually negative, meaning you pay more for the security than you want to, but it can also be positive. When slippage is positive, it means you paid less for the trade than you expected and therefore got a better price.

Slippage can also happen if you place an order with a market maker that doesn’t have enough stock to fill your order. Slippage can impact your returns, so it’s important to be aware of it when trading stocks or other securities.

There are a few things you can do to minimize the impact of slippage, including using stop-loss orders to limit their exposure and placing orders during less volatile times.

1. Use Limit Orders: Limit orders allow you to set a specific price for trade execution, reducing the risk of slippage.
2. Avoid Trading During Volatile Periods Example: “Refrain from placing orders immediately before or after major economic announcements to minimise slippage risk.”
3. Choose High-Liquidity Currency Pairs: Trading major currency pairs often results in less slippage due to higher liquidity.
4. Implement Slippage Tolerance Settings: Many trading platforms offer slippage tolerance settings. Use these to control maximum acceptable slippage.
5. Practice Proper Risk Management Example: “Set wider stop-loss orders to account for potential slippage, especially during volatile market conditions.”
6. Utilise a Virtual Private Server (VPS): A VPS can improve order execution speed, potentially reducing slippage.

Advanced Techniques for Managing Forex Slippage

As you progress in your forex trading journey, consider these sophisticated strategies to further mitigate slippage:

Algorithmic Trading

Implement algorithms designed to execute trades at optimal prices, minimising slippage.

Smart Order Routing (SOR): Develop algorithms that automatically search for the best available prices across multiple liquidity providers. SOR can help you find the most favourable execution prices, potentially reducing slippage.

Execution Algorithms: Use algorithms that break large orders into smaller ones to reduce market impact and slippage. Popular types include:

• Time-Weighted Average Price (TWAP): Executes orders evenly over a specified time period.

• Volume-Weighted Average Price (VWAP): Executes orders based on market volume patterns.

Adaptive Algorithms: Implement algorithms that can adjust their execution strategy based on real-time market conditions, potentially minimising slippage during volatile periods.

Example: “An Iceberg algorithm could be used to execute a large EUR/USD order by dividing it into smaller, more manageable chunks. This approach can help minimise market impact and reduce potential slippage.”

• Liquidity Analysis: Develop skills in analysing market depth to predict potential slippage.
• Order Book Analysis: Learn to interpret the order book to understand current market liquidity. Look for large gaps between price levels or thin areas of liquidity that could lead to slippage.
• Volume Profile Studies: Use volume profile tools to identify price levels with high and low liquidity. Areas of low volume could be prone to higher slippage.
• Liquidity Indicators: Implement custom indicators that visualise liquidity levels on your charts. These can help you quickly identify potential slippage hot spots.
• Market Maker Depth: If available, analyse market maker depth to understand where large liquidity providers are placing their orders.

Example: “By analysing the volume profile of GBP/USD, you might notice that liquidity tends to thin out above 1.3000. This could alert you to increased slippage risk for buy orders around this level.”

Time-of-Day Trading Strategies

Focus your trading activities during periods of higher liquidity to minimise slippage risk.

• Market Overlap Trading: Trade during the overlap of major forex market sessions for increased liquidity. Key overlaps include:
  • London-New York overlap (13:00-17:00 GMT)
  • Tokyo-London overlap (07:00-09:00 GMT)
• Liquidity Heat Maps: Create or use heat maps that show liquidity levels throughout the trading day. These visual tools can help you identify the best times to trade with minimal slippage risk.
• Avoid Illiquid Periods: Be cautious of trading during typically illiquid periods, such as:
  • Daily rollover (usually around 21:00-22:00 GMT)
  • Major holidays
  • Weekends
  • Periods immediately before high-impact news releases
• Session-Based Strategies: Develop strategies tailored to specific trading sessions, accounting for the unique liquidity characteristics of each.

Example: “Consider focusing your EUR/JPY trades during the Tokyo-London overlap (07:00-09:00 GMT), when both European and Asian markets are active. This period often offers higher liquidity for this pair, potentially reducing slippage.”

Advanced Order Types

Utilise sophisticated order types to manage slippage more effectively:

• Fill or Kill (FOK) Orders: These orders must be filled immediately in their entirety, or they are cancelled, preventing partial fills at slippage prices.
• Immediate or Cancel (IOC) Orders: Similar to FOK, but allow partial fills, with the unfilled portion being cancelled.
• Slippage Parameter Orders: Some platforms allow you to set maximum acceptable slippage for market orders.

Example: “When placing a large USD/CHF order, you might use a Fill or Kill order with a tight price tolerance. This ensures you either get your desired price or don’t trade at all, protecting you from significant slippage.”

By implementing these advanced techniques, experienced traders can significantly improve their ability to manage forex slippage.

It’s important to note that these strategies often require sophisticated tools, in-depth market knowledge, and potentially higher initial costs, so you should always evaluate the cost-benefit ratio of implementing such techniques in your trading strategy.

Common Causes of Forex Slippage

1. Market volatility
2. Low liquidity
3. Large order sizes
4. High-impact news events
5. Technical factors

Slippage is simply the difference between the expected price of a trade and the price at which the trade is actually executed. In the forex market, slippage typically occurs during periods of high volatility, when market orders are used, or when a large order is placed on a lightly traded currency pair. Slippage can also occur if a broker does not have enough liquidity to fill a trader’s order at the desired price.

Technology

In the foreign exchange market, there is no centralized exchange where all trading activity takes place. Instead, trading is conducted through a network of banks, brokers, and other financial institutions. As a result, prices can vary from one institution to another. Technology plays an important role in this process, as it enables institutions to connect and share pricing information in real-time. 

As the forex price feeds come from multiple sources, technology provides the price, and therefore, there could be variations from feed to feed, affecting price movements. So, an identical price movement across exchanges is not possible in forex trading, resulting in slippage

Lack Of Liquidity Or Demand

A common reason for order slippage in the Forex market is due to the lack of liquidity or demand for a currency pair. When there are more buyers than sellers in the market, prices will move up quickly and you may see some slippage on your orders. The same is true when there are more sellers than buyers and prices are falling quickly.

Big Position Order 

Another reason that slippage may occur is when a large order is placed. If you’re trying to buy or sell a large amount of currency, it may be difficult to find enough liquidity in the market to fill your entire order at the desired price. As a result, your order may be filled at different prices, resulting in slippage. In this instance, the price will likely go up which will create a higher average price than what you initially requested.

Night Orders

Another time you may experience slippage is if you place an order in the middle of the night. The Forex market is open 24 hours a day, but that doesn’t mean that there will always be enough liquidity to fill your order. If you place an order during a time when the market is less active, it’s more likely that you’ll see some slippage.

Manipulated Prices

Although rare, and now illegal now that regulators are prevalent in the industry, in some cases, brokers may manipulate prices to cause slippage. This usually happens during times of high volatility when there are a lot of market orders. By creating a large amount of slippage, brokers can increase their profits.

If you suspect that your broker is manipulating prices, you should look for another broker. A regulated broker has been approved by a government regulatory body to operate within the industry. For a broker to gain regulation, they must adhere to very strict guidelines set out by the regulating authority.