Imagine trading the E-mini S&P 500 futures (ES) during a volatile market session. You place a market order to buy at 4100.00 but get filled a tick higher at 4100.25. That extra tick cost you $12.50. You do it again, and this time you got filled two ticks higher, costing you $25.
After a few more trades you realize you’ve spent an extra $50 for trades that were filled above your intended buying price. This is called slippage, and it’s the difference between the price you expected to enter a trade and the actual price at which your trade order was filled.
How can slippage impact my profits and losses?
Let’s suppose you traded mainly the E-mini Dow Jones (YM). Slippage on one tick would amount to $5 per contract. If you traded an average of 10 contracts per week, you run the potential risk of paying $50 extra a week if you received slippage on each trade.
If your slippage is two ticks on a given YM trade, then that’s an extra $10 you paid to enter a trade. Do the math based on your average number of trades and you’ll see how this can either take a big chunk out of your profits or increase your losses.
How does slippage occur in the futures market?
To understand slippage, you first need to know how slippage can occur in the transaction process between the Bid and the Ask. Take a look at the Bid/Ask below.
A trader is willing to buy one YM contract at the price of 32540, but the lowest price a seller is willing to sell a contract is at 32545, one tick higher.
If the buyer had placed a buy stop order at the Bid price of 32540, this gets converted into a market order. A market order essentially means “fill me at the best selling price.” That selling price is 32545, one tick higher which in the YM means $5 above the buyer’s preferred price.
So, if the buyer intended on buying at 32540 and selling at 32550, for a profit of 10 ticks or $50, slippage would have amounted to a profit of only 9 ticks or $45.
The trade runs short by $5 which reflects one tick in slippage.
Slippage doesn’t necessarily occur on every trade. Here’s an alternate scenario: a buyer places a stop order at 32540 while at the same time, a seller places a market order first to sell at the best bid price. In this case, the buyer gets filled 32540, the trader’s preferred price.
Are there certain times of markets that are more prone to slippage?
When a market experiences greater-than-average volatility, slippage can occur more frequently, or the degree of slippage can be greater. This can take place in the moments following an economic report, or it can be a sudden news-driven shock.
There are also many instruments that are less liquidly traded that have wide spreads between bid and ask. This is one of the reasons why day traders often don’t trade instruments like rough rice, lumber, coffee, or orange juice. The difference between the bid and ask is large enough to be costly for most short-term speculators.
Can I prevent slippage from happening?
You can avoid slippage if you use Limit Orders, but there’s a catch: you may not get filled.
A limit order essentially means “fill the order at my preferred price or better.” Let’s take a look at the same hypothetical example we used above.
If you place a buy limit order at 32540, then you are likely to get filled at your preferred price (32540) or lower.
The thing is, there have to be enough sellers to cause the market sell orders to hit your bid and possibly even the bids below your preferred price.
If there aren’t enough sellers to match the number of buyers, there’s a possibility that your bid (and those of others) might not be matched with an ask. Remember, when there are more buyers than sellers, price tends to bid upwards, not downwards.
In this case, you won’t experience slippage, but that might be because you weren’t able to place a trade.
The Bottom Line
Slippage can be a costly factor depending on how often you trade and when you choose to trade. The more volatile and illiquid the market, the greater the frequency and depth of slippage. Although slippage is often seen as “the cost of doing business,” it might behoove you to examine how you are trading and whether you’re doing so in the most cost-efficient manner.
Please be aware that the content of this blog is based upon the opinions and research of GFF Brokers and its staff and should not be treated as trade recommendations. There is a substantial risk of loss in trading futures, options and forex. Past performance is not necessarily indicative of future results.
Be advised that there are instances in which stop losses may not trigger. In cases where the market is illiquid–either no buyers or no sellers–or in cases of electronic disruptions, stop losses can fail. And although stop losses can be considered a risk management (loss management) strategy, their function can never be completely guaranteed.