How to avoid slippage

Slippage is the term used to describe the situation where illiquid market conditions mean a trader transacts at a worse rate than they had expected. It is the sworn enemy of all active traders. Slippage can ruin the money management plan of the most disciplined of traders and frustrate to the point of failure even the most composed.

Thankfully though, the evolution of the over-the-counter (OTC) CFD market has been instrumental in providing tools for private traders to reduce their exposure to slippage in the various global markets.

When a stop-loss order or stop-entry order is triggered (by the market trading at a level designated by the trader) the order is filled at the next available price assuming there is the required volume. If the market is illiquid, the order will be filled at a worse level than that designated by the trader – simply because there is not enough volume in the market to accommodate filling the order at the designated level.

The difference between the designated level and the fill level is referred to as slippage. CFD providers differ in their approach to filling orders and in the quality of their executions. The best way to assess a provider’s service is to discuss the various providers with other traders. Online forums are probably the best means of researching these issues as contributors to these forums frequently discuss their experiences and the reputation of each provider can often be very telling.

Slippage is most common in markets that are closed for periods of the day, such as equity markets. The reason is that market-affecting events can occur while the market is closed and the market may reopen at a markedly different price to where it closed. This is also referred to as “gapping”. If a trader has a stop-loss or stop-entry order within the “gap”, they will suffer slippage as their order will be filled when the market opens at the worse-off opening level.

OTC CFD providers can help traders protect themselves from slippage risk by allowing them to guarantee their stop loss orders. Guaranteeing a stop loss order means that the designated level will be the fill level regardless of how much the market gaps through the level.

Guaranteeing a stop loss order costs a certain premium and must be a certain distance from current market levels. Guaranteed orders can only be placed when a market is open. OTC CFD providers differ in the charges they apply for guaranteed stop losses and traders should compare amongst providers to ensure they are getting the best deal. You also need to check whether the guaranteed orders can be moved without incurring extra cost and whether the guaranteed orders have an expiry time. The most valuable guaranteed orders are obviously those that can be moved without cost and have no expiry.

Gapping can actually provide good opportunities for traders if their provider allows them to place Guaranteed Stop-Entry orders (GSE). GSE orders can be used to guarantee a level for an opening trade, irrespective of whether the underlying market gaps through the order level. Astute traders are using GSEs to “break trade” markets to great effect. That is, they place GSEs just beyond support or resistance levels hoping that the market will break these levels and gap to a new level. If this occurs, the trader who has placed a GSE order can find themselves immediately in profit on their trade. They can also attach an if-done stop loss order to the GSE so that their downside risk is limited once the GSE is filled.

Gavin White, Head of Business Development, City Index