What is Slippage?

Slippage, a frequent occurrence in the financial markets, happens when a trade’s execution price is different from the anticipated or desired price.

Slippage is like trying to catch a taxi in a busy city. You hail one and agree on a specific fare (your desired trade price), but you might end up paying more or less due to traffic (market fluctuations), analogous to slippage in trading. Slippage is the difference between the execution price that was planned to be paid and the execution price that was paid.

Causes of Slippage:

Slippage in trading can be a source of frustration for traders since market volatility is dependent on important events like reported earnings and announcements of interest rates. Having an understanding of slippage is crucial, especially when forex rules in South Africa come into play.

Some factors that contribute to slippages are:

1. Market Volatility:

Prices change rapidly in highly volatile markets; hence, fluctuations set in between the time an order is placed and the time it is executed. This volatility can lead to significant slippage.

2. Low Liquidity:

Liquidity affects how susceptible an asset is to slippage and low liquidity increases the likelihood of experiencing slippages. You may experience periods of low liquidity during bank holidays, weekends or late trading hours.

3. Order Size:

Larger orders might not be filled at a fixed cost, particularly in markets with little liquidity. Slippage and incomplete fillings may result from this.

4. Order Type:

Limit orders, which define a price at which you’re ready to purchase or sell, are less prone to slippage than market orders, which execute at the current market price.

Why Does Slippage Matter?

Slippage is an essential part of trading because it determines your relative profit-or-loss market position. Here’s why they are important:

• Impact on Profit and Loss: Slippage can have an impact on a trade’s profitability. While negative slippage, where the deal is performed at a lower price, can result in larger losses, positive slippage, where the trade is executed at a better price, can improve profits.
• Risk Management: It is pertinent that traders incorporate slippage into their risk management plans, as failure to do so can result in unpleasant losses and significant setbacks.
• Setting Realistic Expectations: Knowledge of slippage enables traders to incorporate the occurrence of slippage into their planning. Trades rarely go through at the precise price that was set.

Managing Slippage:

While slippage cannot be entirely avoided, traders can take steps to manage it.

1. Use Limit Orders:

When possible, use limit orders to pinpoint the exact price at which you want to execute a trade. This reduces the risk of slippage.

2. Monitor Market Conditions:

Stay informed about market conditions and volatility and set your trading strategies accordingly.

3. Diversify and Scale:

Instead of putting in large orders that could cause a lot of slippage, diversify your portfolio and grow into positions gradually.

4. Evaluate Your Broker:

A few brokers might provide improved transaction execution and decreased slippage; hence, when selecting a brokerage, take this into account.

Take Home

Slippage is a common aspect of trading that every trader should be aware of. While it can be frustrating, understanding its causes and managing it effectively can help traders mitigate its impact and trade with more confidence. Slippage serves as a reminder that the financial markets are dynamic and often unpredictable, requiring traders to adapt and make informed decisions in response to ever-changing conditions.