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What is Slippage?

Slippage is the difference between the price in the market when you place your order and the price at which it is executed. This occurs because most people in those markets trade "at market", which means "buy me so many contracts at market".

An example will clarify it:

You see a breakout at 1257 points and ring your broker to buy you 10 contracts. Your broker send your order to the trading floor. This may take seconds or minutes, depending on how the broker is set up.

When your order gets to the floor, the operator finds that the market is 1261 bid 1263 offered. So the operator bids 10 contracts at 1263, but only gets 5 contracts. The operator then finds the market is 1262 bid 1264 offered. She bids 5 contracts at 1264, but cannot get them, because the market is rising very quickly. Eventually she gets the 5 contracts at 1266.

The difference between the price at which your buy signal came and the price you got your 10 contracts at is slippage.

It is an important concepts, because, in testing trading systems on past data, you must allow for "normal" slippage. Otherwise, your system may appear more profitable than it should, simply because you could never get your orders filled at exactly the buy signal price in normal markets.

Slippage can be negative, in the sense that sometimes you get your order filled at a lower price. However, since mostly we try to get onto strong trends, it tends to be a "cost" rather than a "gain".

It is also possible to trade using limit orders. Slippage still applies, it is just that the process is different. In our example above, we would phone our broker to place an order to buy at 1257. However, when the broker tells us the market is now 1261 - 1263, we might increase our order to 1262. It would not be filled, so some time later we would have to increase it, maybe several times, until we get a fill. So, again, we are not able too trade at the prices that our system tells us to buy at. This is slippage.

Slippage is a "cost" much like brokerage. We look at a chart and say, "look we could have bought every time the price fell to 1257 and sell every time it got to 1297" and traded a trading range. However, the reality is that the profit would not be 40 points, There might be slippage of 10 points getting in and 10 points getting out. Thus slippage is 20 points of the potential 40 points profit. Brokerage might be another 5 points in and 5 points out, so the real profit potential is not the 40 points we see on the chart, but (40 - 10 - 10 -5 -5) only 10 points. If the risk to our stop is 10 points, what looked like a 4:1 reward to risk ratio is actually a 1:1 reward to risk ratio.