Retail forex trading is done through margin trading as such it is considered as futures trading despite trading on spot forex prices. It therefore falls under the jurisdiction and supervision of the National Futures Association the self-regulatory organization of the futures industry. And one of the most recent and most significant decisions it made concerns forex slippage.
Forex slippage can be used by brokers to make money from their unsuspecting clients. Since most traders have learned to accept it as one of the harsh realities inherent with volatile markets, and so they are totally unaware that brokers are milking them more money than they need to dole out.
In very volatile markets, brokers may not be able to fill up your orders at the price you set but as per trading agreements, they are obliged to execute the order on the next best price. This is actually favorable to a broker who happens to be a market maker at the same time. This simply means your order is not coursed through a dealing desk but processed internally and matched by the broker itself. Any slippage therefore results in the broker’s favor.
But what made the regulating authorities suspicious is the fact that when prices are in their client’s favor, the orders are promptly executed immediately as soon as the targeted price is reached even when there is tremendous volatility in the market.
In other words, forex slippage occurs when market volatility and price movement do not favor the clients whereas there is no slippage even if the market is extremely volatile and the price movement is in the client’s favor, thus denying him of any windfall profit he may have otherwise have received due to market volatility.
The NFA considers this as unfair. In two audits made on two broker firms, they discovered such practices and subsequently fined the erring brokers. NFA believes that any broker who allows forex slippage in its favor must also allow the same in their clients favor. It has since made this a formal rule to be strictly followed by its Forex Dealer Members.
As Forex Dealer Members of good standing with the NFA, brokers are expected to always uphold the interest of their clients above their own. And so to eliminate this rampant practice of most brokers, the NFA issued an Interpretive Order known as NFA Compliance Rule 2 -36 which was subsequently approved by the Commodity Futures Trading Commission (CFTC) and took effect on March 26, 2012.
The Interpretive Notice set the parameters for fair slippage and price requiting. Essentially, it prevents member brokers from manipulating price movements in a way that they will benefit from the resulting slippage. It also contains guidelines on how member brokers must apply slippage without breaking Rule 2-36. In short, regardless which direction prices move, slippage must be applied uniformly. In addition, if the member broker requotes a price when the market is in its favor, it must also requote a price even if a market is not in its favor.