Market gaps and slippage

Market gaps and slippage are among the most common risks traders encounter regularly.

In previous chapters, you learned how to mitigate these risks using stop and limit orders. However, these tools can also be leveraged to gain advantages. Read on to discover how to effectively trade around gaps and slippage.

What are market gaps?

Every trader has a different approach to risk tolerance.

Gaps represent abrupt price movements during which no trading occurs. These gaps can be either upward or downward. In the forex market, gaps primarily occur over the weekend when the market is closed. However, gaps can also appear in shorter timeframes, such as on a minute chart or immediately following significant news announcements.

Examples of situations where gaps may occur:

• When unexpected economic data is released.

• Following major announcements, particularly global or unforeseen events.

• When the market reopens after a weekend or holiday, especially if significant news was announced during the closure.

Why are gaps important?

Gaps can provide insights into market sentiment. For example:

• An upward gap indicates no sellers were willing to trade at that price level.

• A downward gap suggests no buyers were willing to trade at that price level.

It’s essential to be aware of gaps as they can cause stop orders to be skipped, leading to execution at a worse price than expected.

Sometimes, gaps result in corrective price action, meaning prices may reverse and "fill" the gap after it occurs.

How to use gaps to your advantage

When a gap occurs, it’s often wise to stay out of the market. Gaps may indicate strength in the direction of the movement or may "close" as prices reverse to the level where the gap started. If a gap appears just before entering a trade, it might be prudent to reconsider or cancel the trade altogether.

Gap up trading (EUR/JPY, 1hour)

Gap down trading (EUR/JPY, 1 hour)

What is slippage?

Slippage is the difference between the expected price of a trade and the actual price at which it is executed. Market gaps can cause slippage, affecting stop and limit orders and leading to execution at a price different from what was intended.

Slippage can be either positive or negative, depending on the market's movement. It most commonly occurs during sudden changes in the bid-ask spread. For instance:
You attempt to buy EUR/USD at 1.3650. However, following a positive FOMC announcement boosting the US dollar, volatility hits EUR/USD. While your order is being executed, the bid price jumps 10 pips to 1.3660, resulting in your trade being filled at a higher price than anticipated.

How to minimize slippage

Although it’s impossible to avoid spread-related costs entirely in forex trading, you can take steps to reduce the risk of slippage.

• Use limit orders: Setting limit orders ensures that trades are executed only at the specified price or better, minimizing the risk of negative slippage while allowing for positive slippage.

• Trade during stable times: Avoid trading during major events like FOMC or NFP announcements. This strategy gives you breathing room and helps avoid trading during the market’s most volatile moments when slippage is most likely.

• Focus on liquid currencies: Trading major and minor currency pairs, which are known for their stability, can help reduce slippage. These pairs are generally less volatile than their exotic counterparts.