Slippage is a necessary evil in trading which every trader has to deal with whether they are trading in currency pairs in forex or a commodity. It matters even more to day traders. The concept of slippage is a bit intricate; nevertheless, understanding the concept is critical before digging deeper into it.
What is slippage?
In simple terms, slippage is the difference between the expected price at which a trade is to be executed and actual price of the trade. Let’s understand it through an example: Suppose the British pound is trading at $1.55 at a given point and a trader considers it a fair price to place a trade. He places a “Market Buy Order” to purchase 100 GBP if he has $154 in his trading account. In the market order, a trade is executed at the CMP (Current Market Price). Now because of the increased demand, the price of the British Pound moves up to $1.56. As the trade is executed at a higher price than expected, the trader is able to buy just 98 Pounds, which is less than the expected amount.
For every buyer, there should be an equal number of sellers at the same price and trade size and any imbalance increases the volatility at a given point resulting in price fluctuations. When there is imbalance of buyers, sellers, price, and trade volume, prices need to be adjusted to execute trade orders at the next best available price.
Why It Matters
Slippage is a real-world problem for traders that happens because the price and trade size of a Buy order is matched with the Sell order, and vice versa. If not controlled, this increases the cost of every trade that has a very negative impact on your overall trading profit in the medium and the long run. To remain profitable as a trader, slippage should not be allowed to exceed beyond a certain limit to maintain the profitability of your trading account.
When Slippage is More Likely To Happen
The biggest slippage generally happens when the market volatility is very high before a major news event such as FOMC announcements, OPEC meeting, or the European Central Bank meeting. Though the swing in prices may seem alluring, it could result in substantial slippage because of the wild price swings and sudden whipsaws resulting in frequent stoploss hitting.
Traders are exposed to more risks than expected during these short periods and their trading account may be blown out because of these wild swings provided the risk is properly managed. The slippage is very high for illiquid financial instruments where the bid-ask spread in price is wide.
Avoiding Slippage
Slippage can only by controlled with the help of an advanced technology. It can be brought down by reducing latency, which is the time your trading terminal takes to communicate with the exchange trading servers located in London, New York, or Singapore. The further away your trading terminal is from the exchange trading servers, the higher will be the latency and more will be the chance of a slippage.
The virtualized hosting paradigm is the most preferred solution to reduce latency. It divides a single resource into multiple and smaller virtual servers and every virtual server operates completely in isolation with others. Since data is transported to physical servers almost instantly, it ensures your trading terminals are always connected to high-speed Internet. This arrangement is free from traditional hardware issues that obstruct trading speed.
Slippage and What You Can Do About It Click To Tweet