The National Futures Association (NFA) is a regulatory agency responsible for overseeing the activities of firms and individuals in the futures market. It also recently announced that it plans to analyze the trades being executed by its member brokers to see if they are taking advantage of slippage. In line with this, they will investigate whether these brokers have designed computer systems to defraud their retail investors.
Why is the NFA doing this in the first place? You see, the NFA is tasked to protect market participants and ensure the integrity of the futures industry by making sure that its member firms are sticking to the rules of the game.
As I mentioned in one of my old articles about regulatory agencies in action, the NFA, along with the Commodity Futures Trading Commission (CFTC), has been stepping up its game when it comes to dealing with unfair trading practices. In fact, just a couple of months ago the agency issued some warnings to a couple of brokers who were using a plug-in called Virtual Dealer to make sure the slippage was in the broker’s favor.
Now, if you’ve been scratching your head every time I mentioned “slippage”, here’s a quick lesson for you.
What is Slippage?
Slippage normally occurs during very volatile trading sessions, such as right after the release of major news reports. What happens is that an abnormally huge amount of orders in one direction moves prices swiftly, and if you try trading during this type of extremely volatile events, chances are that you will get filled a much different price than you put in.
The reason being is that if there isn’t a matching order on the other side of your order when your limit price is hit, you get filled at the “next best price available.” Let’s remember that when triggered, limit orders turn into market orders, and market orders get filled at the best price available. Depending on the situation, slippage can be 5 pips to as much as 100 pips or more, and this is why we issue caution to trading right after a news release.
Let’s say you’re a brave soul or crazy fool (the lines are fuzzy in Forex trading) who wants to trade the FOMC report. You see that there is a major support level on EUR/USD at 1.3000. You believe that if price trades below this, it would mean a major break and you could grab some serious pips. You set an order to sell at 1.2990.
When the FOMC report comes out, it comes out as a surprise and very dollar positive, and traders react by selling EUR/USD by the boatload. You see the price dip below 1.3000 and you get a confirmation that your trade has been triggered. In your head, you think, “Okay this is good, I’m gonna make mad money!”
However, you soon realize that you didn’t get triggered at 1.2990, but at 1.2950 – 40 pips lower than your original entry!
In a situation like this, there can legitimately not be enough buy orders at 1.2990 to match the tsunami of sell orders coming through. I mean who’s crazy enough to put in buy orders below market around events like these? It makes no sense. But anywhoo, the Forex markets changes prices so fast on a regular basis that you may see the occasional slippage here and there.
Why Would a Broker Think About Doing This?
With some retail brokers setting prices, controlling the order routing process and sometimes taking the other side of the trade, you can imagine how an unscrupulous broker may slip in a pip or two towards your trading costs. Yes, with the technological advancement of the internet and online retail trading, “ethically challenged” brokers can configure their platform settings to unfairly benefit the company at the cost of their client.
To the average trader, a pip or two of slippage may not mean anything more than a few bucks in additional trading costs and is most likely overlooked, but multiply that by thousands of clients who do multiple trades a day in a highly leveraged market, and that adds up to extra moolah in trading fees every day. All very quick and easy with a few button taps, right?
So, by investigating into broker practices, the NFA is aiming to determine whether such technology is fair towards both the broker and the client. And if the NFA finds that the broker is indeed treating its clients unfairly, they will be penalized and asked to pay fines.
Slippage is a trading reality we must all learn to accept in the quick-moving forex markets, but it doesn’t mean we should accept brokers who may take advantage of it. Good thing we have regulators, like the NFA, who are ready to go all Optimus Prime on those wanting to line their pockets with extra padding at the cost of giving us small fries an unfair trade.