Slippage: What Is It and Why Should You Be Wary of It?

Slippage is one of the most frustrating and costly phenomena in trading, affecting both retail and institutional investors. While it is often overlooked by beginners, experienced traders understand that it can seriously impact profitability. This article explores the causes of slippage, how traders can avoid it, and even how they can use it to their advantage.

What is slippage?

Slippage occurs when a trade is executed at a different price than expected. The phenomenon typically happens in fast-moving or low-liquidity markets, where the price of a security quickly changes between the time an order is placed and when it gets filled. 

Slippage can result in a worse price (negative slippage) or, in some cases, a better price (positive slippage), though the latter is less common. For example, imagine a trader placed a Stop-Loss order on XNGUSD at 3.4158. Unfortunately, due to market volatility, the next day the order was executed at 3.6214, greatly enlarging the trader’s loss. This was a case of slippage caused by a price gap.

Causes of slippage

Several factors contribute to slippage. It can be spotted when looking at a chart – pay attention to abnormally long wicks on candlesticks formed in a short period.

• Market volatility plays a significant role, as highly volatile assets, such as cryptocurrencies, some Forex pairs, commodities, and even certain stocks, experience rapid price changes that make slippage more likely. 
• Low liquidity can also be a major factor. In illiquid markets, there may not be enough buy or sell orders at a given price level, causing orders to fill at the next available price. 
• The type of order a trader uses can influence slippage as well. Market orders are more susceptible to slippage since they execute at the best available price, whereas limit orders allow traders to specify a price ceiling or floor. 
• Slow execution, whether due to broker inefficiencies or internet latency, can increase the likelihood of slippage. 
• Additionally, as in the image above, price gaps between market close and market open can result in orders filling at drastically different prices than expected, particularly in overnight trading or after major news events.

How to avoid slippage

While slippage cannot always be eliminated, traders can take measures to minimize its impact.

Use limit orders

Limit orders, unlike market orders, ensure that trades only execute at a specified price or better, reducing the risk of negative slippage.

Choose liquid instruments

Trading in highly liquid markets with tight bid-ask spreads helps prevent excessive slippage, while avoiding trading during high-volatility events such as economic releases, earnings reports, and geopolitical crises can also be beneficial.

Avoid slow execution

Ensuring fast execution through brokers with low-latency processing like Headway and using a stable internet connection minimizes delays that can cause slippage. 

Be mindful of trading hours

Some assets experience low liquidity during certain periods, increasing the risk of slippage. It is common knowledge, for example, that during the Asian sessions (Sydney and Tokyo), the price of most non-Asian currency pairs tends to move slowly, often ranging in a consolidation. It is the task of the London session and the New York session to move the price significantly.

During session breaks, volatility tends to heighten, possibly leading to slippage.

How to use slippage to your advantage

While slippage is often viewed as a negative, savvy traders can turn it to their advantage.

• Arbitrage. Arbitrage opportunities arise when traders can execute trades faster than others, capitalizing on price discrepancies caused by slippage.
• Trading robots. Algorithmic trading and high-frequency trading (HFT) strategies can exploit price movements before retail traders can react.
• Trading slippage. Some traders strategically place stop orders below key support and above resistance levels, anticipating slippage to avoid getting stopped out prematurely. Others can use slippage as a “liquidity sweep” and enter the market just after one happens. 

Market makers also benefit from slippage by capturing bid-ask spreads and profiting from slight price variations that cause slippage for other traders.

Conclusion

Slippage is an inevitable part of trading, particularly in volatile and illiquid markets. While it can erode profits, traders who understand its causes and implement strategies to minimize it can significantly reduce its impact. 

Moreover, advanced traders can even leverage slippage to their advantage through arbitrage, algorithmic and liquidity trading, and also market-making strategies. By staying informed and proactive, traders can navigate the risks of slippage and maintain a competitive edge in financial markets.

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