Managing risk
Understanding market gaps and slippage
Market gaps and slippage are two of the biggest risks you’ll regularly encounter when trading.
In previous sections, you learned how to safeguard yourself against these risks using stop and limit orders. However, you can also use these events to your advantage. Keep reading to find out how to trade around gaps and slips.
What are market gaps?
Every trader has their own tolerance to risk.
Gaps are sharp breaks in price with no trading occurring in between. Gaps can happen moving up or moving down. In the forex market, gaps primarily occur over the weekend because it is the only time the forex market closes. Gaps may also occur on very short timeframes such as a one-minute chart or immediately following a major news announcement.
Examples of when market gaps can occur:
- When economic data is released – particularly if it contains data that the market isn’t expecting
- As major news events are announced, particularly global and/or unexpected news
- When trading resumes after a weekend or holiday—especially if major news is announced in that period
Why are market gaps important?
Gaps can give an idea of market sentiment. When a market gaps up, that means there were zero traders willing to sell at the levels of the gap. When a market gaps down, that means there were zero traders willing to buy at the levels of the gap. They are also important to be aware of because it is possible to gap past a stop order and get filled at a worse price than your stop order.
Gaps sometimes result in corrective price action. In other words, after the gap occurs prices tend to reverse and “fill” the gap.
How you can use market gaps to your advantage
If there is a gap, generally that is a signal to stay out of the market. Gaps can show strength in the direction of the gap or they can “close” by having prices move in the opposite direction of the gap to at least where the gap began. If there is a gap immediately before the entry of a trade, it may be wise to cancel the trade.
Gap up (EUR/JPY, 1 hour)
Gap down (AUD/USD, 1 hour)
What is slippage?
Slippage is the difference between the expected price of a trade and the price at which the trade actually executes. Market gaps can cause slippage which may affect stop and limit orders – meaning they will be executed at a different price from that requested.
Slippage can be positive or negative depending on the direction of the slide and is most likely to occur during an abrupt change in a currency pair’s bid/ask spread. For example, you attempt to buy EUR/USD at 1.3650. However, an FOMC announcement was released today with positive outlooks for the US dollar, creating volatility for EUR/USD. While your order is being transacted, the bid price suddenly jumps 10 pips to 1.3660, filling your buy order at a higher price than expected.
How to reduce slippage
While it is impossible to completely avoid the spread cost when trading forex, certain steps can be taken to minimize slippage during an order.
Setting limit orders which execute at your set price or better will help eliminate the risk of negative slippage while still allowing you to take advantage of positive slippage.
Trading at safer times and in safer markets. Taking a break from trading during major news events like FOMC announcements or NFP releases gives you time to breathe and helps you avoid trading at the market’s most volatile moments when slippage is most likely. You can also focus your trading in highly liquid currencies with low volatility. These include most major and minor currency pairs, which are known to be more stable than their exotic counterparts.
