Volume and Slippage – Value of a Pip and Execution Types
To succeed in the Forex markets and to be profitable it takes more than just trading in the right direction. One needs to find a good broker to trade with and to fully understand what moves markets. We covered the conditions needed for a broker to be considered a good one in previous articles here on this Trading Academy project. Things like the type of the broker, the accounts offered, etc., are part of the whole trading process. While it seems that it is not that important if the trade is good, on the long run it is crucial. Errors can be avoided and understanding this can spare you a lot of pain. Besides the technical and fundamental analysis that must be considered before opening a trade, the value of a pip and the execution of the trade come next in line. Both are influencing the outcome of a trade. Moreover, traders should not only look at a trade but at the whole trading process. After all, it is important for the account to grow in time, but this doesn’t mean that all trades must be successful. This is quite an impossible thing in trading in general and in Forex trading in particular. The sooner the trader understands that, the better. Therefore, besides the analysis that backs a trade, the value of a pip and how to execute the trade are key. If you come to think of it, these two are part of the overall money management system.
Volume and Execution
The volume traded is the one thing that makes a difference between an account that grows and one that fails. A trader may be right ten times and make money on a 0.1 volume/trade, but then be wrong one time on a two lots trade and the damage would be bigger.
How to Treat Volume
As part of any money management system, choosing the right volume is half of the overall success. Therefore, I deep analysis is needed before even taking the first trade in any trading account.
Size of the Trading Account
Volume should be directly proportional to the size of a trading account. If a trader deposits one thousand in a trading account, it is not wise to trade one lot, as the account will be depleted in a blink of an eye. Also, trading 0.01 micro-lots would be irrelevant as this approach on such an account size is way too conservative. Therefore, the idea is to find the perfect balance between the account size and the volume traded. This is money management. And this can properly work if one can define the potential drawdown in an account.
For example, let’s assume a five thousand trading account and the initial trading volume is 0.1. This means that for every pip earned, on average, the account will grow with $1, if the U.S. dollar is the denominated currency in that trading account. The opposite is true as well: every pip lost brings a $1 loss. This is trading, and it has to be a start for every trading strategy.
Number of Open Positions
However, this is not everything. Volume refers not only to the actual trading volume of a position but also to the number of positions one can open at any one moment of time in a trading account. This is equally important as, even if you trade 0.1 lots, if you open a thousand positions it is like you’re trading with a bigger volume. Therefore, limiting the number of trades open is the key to moving forward. Assuming the account loses 50% of its size, the trading volume should be split in half as well. The same is valid if the trading account gains 100%: the volume should be doubled. Conservative traders will have a strong tendency to split the volume is more than a half, and to increase it with less than 100%, while aggressive traders will always try for more. With the right strategy, both types of traders may succeed.
Execution refers to both the way the trade is opened and the way the broker executes it. Slippage is something that must be avoided at all costs. Slippage means that the broker is not able to execute the order at the indicated price. For example, if you have a pending order to buy EURUSD at 1.0820, and the broker is filling the order at 1.0827. That difference of seven pips, it is called slippage, and it means the broker wasn’t able to fill the order at the right price. This is happening when the market is traveling fast, due to economic events that are causing a surge in volatility. Another reason for slippage is a huge volume. If you try to trade a hundred lots multiple times in a trading day, the broker won’t be happy and consequently will fill you at different prices. The reason for that is the fact that markets are illiquid during some times in a trading day, and the broker cannot fill huge volume if the price happens to reach your entry level during such a time. Therefore, slippage occurs. To sum up, both the volume traded and the slippage that appears at execution are influencing the performance in a trading account. Understanding how to control them is key to make it in this highly competitive Forex environment.
Recommended Further Readings
- Why Trading Forex?
– Advantages and disadvantages of trading the currency market, what are trader’s expectations and what is a realistic approach to follow
- What is a Forex Broker and Types of Brokerage houses
– Explaining what a Forex broker is and does, how the business should be organized, and how many types of Forex brokers exist.
- Financial Products to Trade
– Different categories of financial products that a Forex Broker is offering for the retail clients, starting with the classical currency pairs, and continuing with commodities, CFD’s, indexes, etc.
- Forex Trading Sessions and Their Importance
– Explaining the differences between the three Forex trading sessions, what are their importance, ranking, etc.
- An investigation of Forex market efficiency based on detrended fluctuation analysis: A case study for Iran. Abounoori, E., Shahrazi, M., & Rasekhi, S. (2012). Physica A: Statistical Mechanics and its Applications, 391(11), 3170-3179.
- Algorithmic trading system: design and applications. Wang, F., Dong, K. and Deng, X., 2009. Frontiers of Computer Science in China, 3(2), pp.235-246.