How to Side-Step Slippage
11/26/2012 6:00 am EST
With a lot of other moving parts to worry about before you even place your first trade, this factor might sometimes escape your notice, but it could have a huge impact on your trading success, writes CoachShane of NetPicks.com.
There are some things that really are not thought about on a deeper level. That is where educating yourself on how the markets work can really come in handy. Frankly, I don’t really blame the average person for not looking at the markets with too much depth. Why? Here is a tag line on some online sales page: “No trading experience is required to use it—and profit from it!” Simply put...having no idea about anything related to trading can earn you a profit. The entire trading education and system industry, with a few exceptions, makes it appear that even if you don’t have a working lobe in your brain, you can make money.
No. You can’t. You don’t have to be a Harvard graduate but you have to understand certain things in order to have any chance of success.
Someone asked me the following question:
“If you have made it past the learning curve and are consistently profitable, what is to stop you from trading 10, 20, 50 contracts of anything?”
I can sum the answer up in one word—slippage.
In most markets, a handful of contracts generally have no slippage when traded during the peak hours of market activity. However, keep in mind that for you to buy/sell anything, you need someone to take the opposite position. You also need to have enough contracts available on the other side of your trade to buy/sell.
Let’s put it this way: I want buy 15 contracts of XYZ at 1.32. If there are 15 available, and I am the first in line, no problem with the fill. But, if there are only 5 at that price, what happens? I get my 5 filled at 1.32. I still need 10 more filled so price goes up the ladder. 5@ 1.33. 5 @ 1.34. See the slippage getting in on the trade? Average price is 1.33 giving me 1 point in slippage…on the entry! What if the scenario plays out when I get out? Another 1 point in slippage giving me a total of 2 points of slippage. It can even get worse than that!
Those two points can add up over time and can even take a highly profitable strategy and turn it into a mediocre one. That is why those who trade with size do not take a position at just any price point. The slippage alone can wreak havoc on their bottom line. There is a reason price “appears” to gravitate to clusters of trading activity. There is a reason price “appears” to float up/down to a level where stops have accumulated, spikes them out, and then continues in the intended direction. That, though, is a topic for another article.
When trading, make sure you are trading size that will not generally encounter slippage. While you may not be able to avoid it all the time (like during high volatility), you can certainly reduce the chances of it happening. On that note, keep in mind the times of day you are trading. Lower volume time periods can also make you the victim of slippage on your positions.
By CoachShane, Contributor, NetPicks.com