Slippage is one of the many bits of lingo you’ll often hear investors speak about when they are trading in the forex market. Like any niche industry, the world of forex is filled with a variety of acronyms and terminology that can often be confusing to newcomers. It turns out though, that slippage is not as complicated of a concept as you may have initially thought.
For those curious about understanding slippage in the forex market, we’ll demystify the concept by providing some basic examples to help drive across the point. Let’s start by defining what slippage is.
How is Slippage in the FX Market Defined?
A simple definition of slippage in the forex market is the execution of a market order at a different price than what was requested. For example, let’s say you decide to buy EUR/USD at the current price of 1.2500 but your trade gets executed at 1.2510, which is 10 points worse. In this hypothetical example, you experienced 10 points of what we’ll refer to as negative slippage.
The reason this concept is known as slippage is due to the fact that the order was not filled at the requested price, rather a price that was slightly worse than what you requested. It’s important to highlight that slippage doesn’t always have to be negative. In fact, slippage can work in the favor of traders as well. The most common form of what’s referred to as positive slippage often happens around news events.
Why Does Slippage Occur?
Slippage is common in all markets, not just the forex industry. Those new to forex trading, however, will often associate slippage with broker manipulation. Although this situation does occur, especially with unregualted brokerages, it would be wrong to assume slippage is ever and always a manipulative tactic used by greedy brokers. As mentioned, this is a concept not limited to the FX market but all types of trading such as futures and stocks.
The reason slippage occurs is the simple fact that there is not an unlimited amount of liquidity, also known as pricing availability, at each specific price level in the FX market, or any market for that matter. When there is no supply or liquidity at the price rate you’ve requested, then the market must adjust to the next available price.
Understanding Slippage in the Forex Market
An example should help to better understand how slippage works. When trading currencies, the interest rate that central banks offer has a significant impact on the future price of the currency. The reason is that as the interest rate rises, it becomes advantageous to shift money into the currency offering a higher yield and away from a currency offering a less competitive yield.
Because of this simple fact, currency prices will often exhibit extreme movements when central banks either lower or raise their interest rates. For example, let’s imagine you were trading GBP/USD just minutes before a scheduled interest rate announcement. Before the news, the price of GBP/USD was at 1.3700. It’s then announced that the Bank of England increased their rate by 75 basis points, sending GBP/USD to 1.4000 in a matter of seconds.
The hiking of interest rates is bullish news for a currency, which is why the price in our example went up. With such positive news, would you consider selling GBP/USD? Obviously not. This is why the price spiked, or jumped all the way to 1.4000 in our example.
It’s clear that selling at 1.3700 makes no sense but at some point the price gets too high and a seller jumps in. If you were trying to trade around this announcement, you’d experience slippage. Why? Because nobody would be willing to sell to you at 1.3700. The way all markets function is that if you want to buy, you must find a seller and vice versa. For this reason, if you had a trade at 1.3700 and attempted to place a buy order around the announcement, you most likely would experience slippage, and receive a worse price for your order.
Conversely, if you had a limit or take profit order in this example, you may receive positive slippage as the order would be closed at the next available price, which often is better than the price you requested.
Do You Require Further Guidance? Don’t Hesitate to Contact Our Team of Forex Industry Consultants Today!
If you are interested in learning more about trading the FX market, looking for a reputable broker or are interested in launching your own IB or broker business, we are more than happy to assist you.
To schedule a call with one of our seasoned FX consultants, don’t hesitate to contact our team of specialists today!