In this article, we’ll look at what slippage is, what causes it, and how to avoid it.
What is slippage in trading? This phenomenon could make or break any novice investor, therefore knowing exactly what it entails is crucial. In this article, we’ll analyze the process of slippage and how traders can avoid it.
Slippage is a concept closely related to volatility and price fluctuation. It is, therefore, at the very core of trading as a profession.
So let’s see what slippage is, when it occurs, and how to avoid it.
What is slippage?
In financial terms, slippage is the difference between the expected price of a trade and its actual price when executed. Essentially, it’s the phenomenon of price change between the moment a trader places his order and the moment the system processes it.
Therefore, slippage is neither positive nor negative. It’s a miscalculation by the system, or rather it’s the physical limitation of the system of processing the trade the instant it is executed.
By definition, trading is an extremely volatile profession. Trading apps and online platforms have become extremely accurate, with prices in the order of several decimal points of precision.
At the same time, however, this precision makes slippage more common.
For example, a trader may trade EUR/USD on the Forex and place an order at 1.0874. However, the second after he placed this order and the second before the app processes it, the exchange rate changes to 1.0875. In this case, the slippage is extremely small and causes limited damage to the trader. In other cases, however, slippages can be seriously harmful to an investor’s wallet.
When slippage can be positive
Though it’s generally regarded as a negative thing, slippage can actually have unexpectedly positive effects.
Indeed, the price of an actual purchase can be lower than what the trader expected, allowing him to pay less than forecasted. However, this too can be a double-edged sword.
Perhaps the trader was placing a short position, and the price suddenly lowering will make him miss out on potential profits. In general, slippage should be defined as a neutral phenomenon. The price goes up or down regardless of the trader, and it’s up to him to gather the profits or the losses.
The only objectively negative thing about slippage is its seeming causality. The price changes instantly, apparently without a precise reason to do so at that very moment.
This is, however, not completely true. Indeed, understanding why slippage takes place at a particular moment is very important to avoid it.
Why does slippage occur?
The most common moments when slippage usually occurs is at times of high volatility on the market. For example, Apple’s stock price is more likely to cause slippage the day or week of its quarterly earnings release.
Some naturally volatile markets, like Forex or the cryptocurrency sector, can always generate slippage. Nevertheless, there are moments where such volatility increases. For example, if the Federal Reserve meeting to announce the new monetary policy is coming soon, investors should be aware of any possible slippage in financial markets.
In the case of online trading, slippage can also be a connectivity problem. If the network is slow, the system can take a few seconds to process the trade, during which time the price could be subject to change.
How to avoid slippage in trading
With this in mind, there are a couple of tips that could help traders avoid slippage.
First of all, traders should avoid placing orders in active market moments. For this reason, traders should also always be careful about financial news, knowing when a specific market may be subject to sudden change.
If traders absolutely want to place an order at a specific moment, even if it takes place during a chaotic time, using limit orders could be the solution. With limit orders, the broker places the trade automatically at the exact price level requested by the trader. Today, limit orders are available on most trading platforms.
Finally, a good way to avoid slippage is a secure, fast, and safe internet connection. This way, connectivity problems will be reduced to a minimum and the experience will not be ruined by unpleasant accidents.
