Understanding How and Why Forex Slippage Happens

Aug 7 • Forex Trading Articles • 1468 Views • Comments Off on Understanding How and Why Forex Slippage Happens

Most traders do not really care about how or why forex slippage happens. It is enough for them to accept that every once in a while it happens in very volatile markets and that there is really nothing they can do about it. The more curious however would like to have a deeper understanding of how slippage happens.

Forex slippage results when there is a sudden market volatility often triggered by breaking news that greatly impacts the market. It could be anything like a sudden announcement of a rate cut or a rate increase by a central bank, or a grossly disappointing economic data which came out worse than most analysts predicted, or a debt crisis that can send ripples to major financial centers, etc. Such events often trigger panic trading that pushes prices in either direction so suddenly and so dramatically that orders pile up. As a result, brokers encounter bottle necks in filling up the orders while the price continues its rampage.

Forex orders are filled up through brokers who are electronically linked to other brokers, banks, and other financial institutions sharing the same trading platform or network. Normally, an order is filled up instantly by matching them with an opposite trade within the system. But when there is a sudden rush of buying orders entering the system at the same time, the system may encounter problems matching the orders. At this point, sellers will only be willing to sell at a premium and so the price jumps up to levels acceptable to the sellers; and it will continue making significant price jumps until the buyers and sellers reach an equilibrium at which point the prices stabilize.

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It might interest you to know that there are basically two types of forex brokers – the regular brokers and the market makers. Regular brokers accept your orders and course them to a market maker for a match up. Market makers, on the other hand, are banks or other financial institutions which have ready buy and sell prices to match up orders thrown to them by other brokers. They set the price on which they are willing to match orders. Quite often, they take the risks themselves and to compensate for this they jack up the price to a level that makes the risk worth taking. This results in sudden jumps in prices. Forex slippage results as a consequence of this.

Slippage is not really a problem with forex traders.  They have learned to accept them as one of the realities of trading volatile markets. The more experienced traders make allowances in their trading plans for forex slippage. In the first place, it becomes a trader’s concern when exiting a position in very volatile markets. And generally, you close your positions in very volatile markets to avoid further losses.  Trading wisdom dictates that it is better to be out of the market smarting a loss than to maintain a losing position that may even lead to the total wipe out of the account.

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