One of the major costs of forex trading you can encounter beyond the commission or spreads is the slippage that can occur when placing trades. Slippage is the delay that can occur between the time you place your order and the time the order is executed at the exchange or execution venue. The more latency in a traders systems or brokers. The larger the time between the order being placed and execution the larger chance for slippage to occur in online trading.
This can happen in any market, especially fast moving markets with high volatility, and need to be taken into account when calculating your cost of trading. When you have large news announcements you can find the market will react violently, especially if it goes against the forecast, and due to this price levels can be missed.
Strategies that tend to suffer the most from slippage are trending strategies due to you looking to buy or sell an instrument that is already moving in the desired direction. The strategies that tend to do well or receive positive slippage are the mean reverting as they are going against the current trend.
E.g You are looking to buy WTI for a price of 46.80 which you can see on the screen. When you press the buy button on your platform the order will need to route from your platform to the broker, then from the broker to the liquidity provider. During this time, which can be hundredths of a second, the price could either go up or down. By the time the trade executes the price may have fallen to 46.78 which has given you 2 points of positive slippage. This can also go in reverse where the price may go to 4682 which in this case you would have lost 2 points in negative slippage.
How can I avoid Slippage?
There are a few simple tricks that will minimize the chance of you receiving it.
The Broker – All brokers will have liquidity provider, usually large banks, and broker and the quality of these can cause an effect. Normally the larger the quantity and quality of provider fewer occurrences of slippage will take place.
The Trading Strategy – As covered in the above, the type of technical analysis you use, can increase the slippage you receive. Obviously, I am not advocating not using a trending strategy but you will only want to take the trade when the payoff for the increased risk you are taking is worth it.
Time of Trading – FX trades 24 hours a day 5 days a week and due to this there can be better times to trade but of course this will all depend on your strategy. During the New York Close and the opening of the Asian sessions, you will find that the liquidity will reduce and due to that slippage can increase. You must give special attention to the last few seconds and the first few where the market participants will be pulling lots of order and putting on new ones.
News Announcements – One of the most if not the most volatile time to trade is around major news announcements. These can consist of GDP, CPI, PMI or NFP to name a few. You will need to be aware of when these releases are made as they can move the market and can ruin chart patterns and technical analysis. Use an economic calendar to help avoid these times unless you are trying to trade the new, and if that is the case be prepared to receive slippage.
What you Trade - Slippage can be dramatically different depending on what you are trading. The more actively traded products will generally have a much greater amount of liquidity which means orders are less likely to be slippage or the amount of slippage would be reduced. You will want to trade the major forex pairs such as GBPUSD, USDEUR, GBPEUR, USDJPY, USDCHF and a few others.