Slippage

Why have I devoted an entire section to slippage? Well I think it’s very important that anyone new to spread betting is aware that they can be affected by slippage.

Slippage is when any type of order you place gets filled at a worse price than you intended. I personally have suffered slippage on a few occasions. Once when buying into a trade and once when being stopped out of a trade.

A reader of my blog also has suffered greatly from slippage, so much so that he is now only using guaranteed stop orders on all of his trades. You can read his account here.

So what can we do to minimise slippage?

Well as I’ve mentioned one way is to only use guaranteed stop orders. The only problem with guaranteed stops is that you have to pay for them by way of a bigger spread. You can (like me) use non-guaranteed stops but you do take the risk of slippage.

I think there are cases for both sides of the argument here and it basically comes down to the individuals preference. Lets look as some examples.

Spread Better A.

Spread Better A always trades with a guaranteed stop loss in place. He pays an extra 2 points in spread on every trade he makes. He makes 100 £1 per point trades in one year so he’s paid an extra £200 over the year to guarantee he never gets affected by slippage. This is good news because one of his long trades went bust over night. He brought the stock at 140p at £1 per point with a guaranteed stop set at 120p. He lost £20 on the trade but saved himself an extra £120 by having a guaranteed stop.

Therefore over the year he has spent £200 on stops but saved £120 on slippage. Therefore he’s paid an extra £80 than he would have needed to if he had used non-guaranteed stops.

Spread Better B

Spread better B always trades with a stop in place but they are never guaranteed. He has made 100 £1 per point trades this year. One of his Long trades went bust over night. He brought the stock at 1207p. He had a stop in place at 1175p. He was only expecting to lose a maximum of £32 on this trade, but because the stock went bankrupt and fell to 0 over night it ended up costing him £1207, so £1175 more than he had anticipated. If Spread better B had used a guaranteed stop on all of his trades he would’ve spent £200 over the year but saved £975 on the one bad trade.

Now don’t take these examples to literally because both of them are worst case scenarios. I’ve been trading for a few years now and I have only see this sort of thing happen once, and that was to someone else. I have suffered slippage but not because the company went bust, I suffered it because the market was trading really fast and I had my stop set to close to the current price. It ended up costing me about £20.

I think the important lesson to take from this is that it can happen. Trading without guaranteed stops involves extra risk, but as long as that risk is considered it should be no different.

I think personally it’s a good idea to trade with a guaranteed stop on higher priced stocks that can potentially fall to zero or risky companies that could potentially go bust.

Another thing to note is I have only covered the long side of slippage. Slippage of course can occur if you are short. You might think that a stock price will not rocket that fast but believe me stock prices can and do go up just as quickly as they fall.