i. Slippage is the difference between price at which the order was sent and at which the order was executed.
ii. Low liquidity and volume will result in high slippage.
iii. Traders need to keep slippage low.
Slippage is the difference between the price at which the currency was bought or sold and the price at which the order was executed in the forex market. Slippage is caused due to low liquidity in the market when not many traders are trading.
What is slippage?
Slippage is the difference between the expected price of a trade and the price at which the trade is executed.
For example, let us say you decided to buy USD/JPY at 107.169 and when you executed the trade it took a while for your broker to open that trade(or fill your order) and when it finally did the price went at 107.180. This happens due to slippage.
What is the real cause of slippage in forex?
1. low liquidity and high volatility
There can be many causes to slippage, but the most common cause is low liquidity and high volatility. When there is low liquidity in the market, there are not enough buyers and sellers present in the market to fill your order.
And as in forex, the price tends to move continuously, the broker executes your trade at the next possible price.
Due to this very reason, your trade gets executed at a different price rather than opening at your expected price.
Slippage can also happen when the volatility in the market is very high, especially during the news.
You must have observed, during news releases the price tends to move very impulsively and many times we see that the spreads are too wide, and sometimes it even forms gaps.
When there is high volatility in the market the price tends to change very quickly and so sometimes it is hard for the broker to execute your trade at your desired position.
And so your trade is executed at the next available position.
Is slippage bad?
No, it isn't. The real market is prone to slippage and there is nothing to worry about. No matter which forex broker you use, your account is prone to slippage.
Plus, slippage can sometimes be negative for you, and sometimes it can even be favorable for you.
For example, let's say you wanted to buy USDJPY @ 107.169 but due to slippage, the price went to 107.139, and your trade got executed (order got filled) at 107.139.
Congratulations, this time slippage saved you 3 pips of drawdown. Slippage is not always a bad thing and it is completely normal in the forex market.
How to avoid slippage in forex?
Now before I begin, you should understand what slippage is actually.
Slippage is something that cannot be completely avoided, sometimes you will have to acknowledge it and start reducing as much risk as possible and also take measures to avoid it until a possible extent.
Because that's the only thing you have control over and it is the wise thing to do.
Luckily, there are a few easy ways by which you can avoid slippage to some extent.
1. Trade the pairs with low volatility and high liquidity
As I mentioned earlier, one of the main reasons for slippage is quick price movement and fewer buyers and sellers in the market.
So, the best thing to do is to avoid trading pairs that have very high volatility and also pairs with low liquidity.
Trade on pairs like EURUSD, GBPUSD, or the major currency pairs, and if you are a day trader make sure you be more active during the London and New York session as they provide high liquidity and so slippage will be less or you will very rarely get affected by it.
2. Avoid trading during an economic news event
One of the most important causes of slippage is high volatility, and we all are well aware of how the market moves during the time of news.
The volatility in the market is the most during the time of news events and market orders are prone to slippage during this time.
So, the best thing to do is avoid trading 30 mins prior and only start the trade 30 mins after the news release.
And if you are already in a trade then use a stop loss or just get out of that trade before the news kicks in.
Especially for day traders, you should avoid trading during a news event as slippage during this time is the worst and probably can cost you your account.
So, It will be wise to avoid trading during a news event.
3. Trade during sessions when the volume in the market is high
More traders are active during London and New York sessions giving more volume to the market. Trading during these sessions provides traders with high liquidity and hence the market is less prone to slippage.
Furthermore, there is a time in the market when the new york session and London session overlaps, and during this, the liquidity in the forex market is at a peak. Therefore many scalpers only trade during these hours.
4. Use limit orders
The next and the last thing which can be done to avoid slippage is by using limit orders.
Slippage mostly happens with the traders who use market orders or market execution to open a trade or exit a trade. All limit orders are immune to slippage.
For those who don't know what is a market order and limit order, a market order is an order to buy or sell at the current best available price, and a limit order is an order which can be set at the position you want your trade to open, and the trade only opens if the price reaches the level of your limit order.
So, by using a limit order to open a position you can avoid slippage, as a limit order is only filled when the price is at your desired price.
For example, If you set a buy limit on USD/JPY at 117.000 and the current price is at 117.050. If slippage occurs and price directly slips to 116.990 your limit order will not get filled as the price didn't come to 117.000 and directly slipped below it.
But then using limit orders are not suitable for every trading styles plus it has some other disadvantages like sometimes your order may not get filled.