The Truth About Slippage: How It Impacts Your FX Trades

In FX trading, slippage refers to the difference between the expected price of a trade and the actual price at which the trade is executed. This often occurs in fast-moving markets where prices can change rapidly, leading to orders being filled at a different price than anticipated.

But is there more to it? Let’s explore slippage from a technical perspective.

Slippage from a technical perspective 

Slippage can happen throughout the journey of an order execution process. It can be classified in 3 different categories, which will be discussed below.

Pre-execution slippage

Slippage may occur before the order reaches the trading setup, and this may be due to how the broker’s infrastructure setup.

Assume the broker’s main infrastructure is based in London, and their customer base is in Asia. If a trader places a trade from Asia, it may take around 100-200 milliseconds for the order to reach the broker’s infrastructure. While the order is travelling to the connectivity engine, if LP updates their price, the connectivity engine will also receive the latest price as well. This pre-execution slippage is due to latency for the order to reach the broker’s setup.

Depth of Market (DOM) Slippage

Each Liquidity Provider (LP) offers multiple layers of liquidity, presented to the broker as a liquidity book. Each layer of liquidity has its own pricing, (lowest price on top, highest price on bottom), and have their own available volume.

If a large trade is sent to the broker, the order maybe split into smaller size to fulfil their large order. For example, if a trader places an order of 1 million units but the liquidity book only has 0.5 million at the Top of Book (TOB) layer, so for the broker to fulfil the order, the broker will try to execute the remaining order with the available liquidity on the 2nd layer of the liquidity book. (ie. Executing the remaining order with a higher price, but with more volume. E.g. 2nd layer contains 1million in volume).

The order will be displayed to the client as a slippage, as the price given is a Value Weighted Average Price(VWAP).

Maker Slippage

Following on from the above, where the order is split into smaller orders due to availability of liquidity in the market, the order will reach the Maker (Liquidity Provider, aka LP). The LP may fill the order at a different price, due to further price changes or there maybe an error from the LP’s side. This may cause further slippage.

Conclusion

From a client’s perspective, they are getting a slippage. However, the real reason for the slippage is because of the following equation:

Slippage = Pre-execution slippage + DOM Slippage + Maker Slippage

How can brokers explain slippage to clients?

Brokers shall be able to explain to the clients the cause of slippage and provide relevant solutions and answers to the clients:

Pre-execution slippage results from the physical distance between the client and the broker’s infrastructure. This can be solved if the broker can offer the client a VPS that is hosted very close to their server.

DOM slippage is due to the insufficient liquidity from the LP. The broker shall explain to the client that at the moment of the execution, there is not enough from the LP to execute their order, hence they get a slippage price or VWAP.

Maker slippage should not happen, and broker shall seek to find out from their LP(s) to see why the order was not executed based on the LP’s advertised price.