Describe the impact of slippage on the effectiveness of trailing stop loss strategies.
Impact of Slippage on Trailing Stop Loss Strategies
Slippage, the difference between an order's intended execution price and its actual executed price, can significantly impact the effectiveness of trailing stop loss strategies.
Types of Slippage:
Market Slippage: Occurs when the market moves rapidly against an order, causing it to execute at a less favorable price.
Broker Slippage: Occurs due to brokerage fees and spreads, which widen the gap between the quoted price and the executed price.
Effects on Trailing Stop Loss Strategies:
Delayed Executions: Slippage can result in trailing stop orders executing late, allowing the price to move further against the trader before closing the position.
Premature Executions: Market slippage can cause stops to trigger prematurely, exiting a winning trade unnecessarily.
Reduced Profitability: Constant slippage reduces the profitability of successful trades, as the realized exit price is often lower than the intended one.
Increased Risk: Delayed executions or premature closures due to slippage can increase the risk of losses, as positions are not exited at the desired levels.
Examples:
Example 1 (Delayed Execution): A trader sets a trailing stop loss at $100. However, due to market slippage, the order executes at $98.50, allowing the price to continue falling and increasing the loss.
Example 2 (Premature Execution): A trader sets a trailing stop loss at $120. Due to broker slippage, the order triggers at $119.80, closing the trade prematurely and forfeiting potential profit.
Mitigation Strategies:
To mitigate the impact of slippage, traders can:
Use limit orders instead of market orders for stop-loss executions.
Choose brokers with tight spreads and low execution fees.
Set the trailing stop at a greater distance from the current price to reduce the likelihood of premature triggering.
Monitor market conditions and be prepared to manually adjust stop levels during periods of high volatility.