What is Slippage?
Slippage is when an order is filled at a price that is different than the requested price.
Most conversations I hear regarding slippage tend to speak about it in a negative light, when in reality, this normal market occurrence can be a good thing for traders. When orders are sent out to be filled by a liquidity provider or bank, they are filled at the best available price whether the fill price is above or below the price requested.
To put this concept into a numerical example, let’s say we attempt to buy the EURUSD at the current market rate of 1.3650. When the order is filled, there are 3 potential outcomes.
Outcome #1 (No Slippage)
The order is submitted and the best available buy price being offered is 1.3650 (exactly what we requested), the order is then filled at 1.3650.
Outcome #2 (Positive Slippage)
The order is submitted and the best available buy price being offered suddenly changes to 1.3640 (10 pips below our requested price) while our order is executing, the order is then filled at this better price of 1.3640.
Outcome #3 (Negative Slippage)
The order is submitted and the best available buy price being offered suddenly changes to 1.3660 (10 pips above our requested price)while our order is executing, the order is then filled at this price of 1.3660.
Anytime we are filled at a different price, it is called slippage.
What Causes Slippage?
So how does this happen? Why can’t our orders be filled at our requested price? It all goes back to the basics of what a true market consists of, buyers and sellers. For every buyer with a specific price and trade size, there must be an equal amount of sellers at the same price and trade size. If there is ever an imbalance of buyers or sellers, this is what causes prices to move up or down.
So as traders, if we go in and attempt to buy 100k EURUSD at 1.3650, but there are not enough people (or no one at all) willing to sell their Euros for 1.3650 USD, our order will need to look at the next best available price(s) and buy those Euros at a higher price, giving us negative slippage. But of course sometimes the opposite could happen. If there were a flood of people wanting to sell their Euros at the time our order was submitted, we might be able to find a seller willing to sell them at a price lower than what we had initially requested, giving us positive slippage.
Which currency pairs are the least prone to slippage?
Under normal market conditions, the more liquid currency pairs will be less prone to slippage like the EUR/USD and USD/JPY . Although, when markets are volatile, like before and during an important data release even these liquid currency pairs can be prone to slippage.
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---Written by Rob Pasche