In order to trade in the financial markets, you need a common place and a middle party to match the buyers and sellers. The middle party is called an Exchange.
At its essence, an exchange serves as a market where financial instruments such as securities, commodities, and derivatives are listed then offered to be bought and sold. Its primary role is to facilitate orderly and impartial trading and provide timely and accurate price information for all securities listed on the exchange.
Through an exchange, companies, governments, public investors, hedge funds and other entities have the opportunity to offer their securities to the everybody, establishing a platform for public investment.
Because Exchanges are huge they delegate public trading accounts to brokers.
I will describe three most common type of brokers:
Brokers make their money from commission on your transaction, for example typical commissions in North America today are:
1 cent per (ETF or Stock) share traded,
$2.5 per futures contract traded,
$1.5 per option contract traded
these commissions includes exchange fees (which are very low because they have high volume).
This type of broker connect you directly to the exchange where you will automatically be matched to the best offer if you are buying or the best bid if you are selling. This produce the best fills most of the time, as you are going through the exchange best bid/offer.
TradeStation, Interactive Brokers, falls under this type.
Second type of brokers, might offer much lower commissions or even free, but then they aggregate all orders and sell it to a bigger broker to facilitate the execution of the transaction. The bigger broker, typically a Market Maker match buyers and sellers on their books then you fill the rest through the market if needed, typically you get a little worse fill than Type 1, but for infrequent small orders it is insignificant, and convenience trumps here. Robinhood falls under this type.
Third type of brokers will not match your order with the market, instead they will be the opposite party to your transaction, so if you are buying they will sell to you, and if you are selling they will buy from you. Since the incentives are completely not aligned, the customer always lose. While this use to be around in stocks/futures, but not any more. Today it is prevalent in Forex and special derivatives. Goldman Sachs for example screwed Michael Burry when he tried to cash out after the Subprime Bubble burst in 2008, because they were the opposite party of his trade, and they kept inflating the price of the assets artificially so they don't have to buy from him at a loss. You can watch the excellent movie The Big Short to see how it unfolded.
Derivitaves however is only for big dogs, so we'll leave that alone, but Forex is where all retail traders are taken to slaughter.
Forex brokers use every trick in the book to siphon all your money. they artificially inflate/deflate spread, slippage, even price, because not only they are the opposite party, but they are also the price quote source, so while currencies are traded globally, but there are huge discrepancies in prices, depending on your broker. It's not uncommon not to get filled even when currency price pass your price level.
99.9% of Forex brokers fall under this type.
Slippage is the difference between the anticipated price of a trade and the actual price at which the trade is executed. This can happen at any time in any market. With type 2 and type 3 brokers, you are at a huge disadvantage so there is no need to talk about slippage with those types as that will be your last concern. Instead we will focus on slippage for Type 1 brokers only. Slippage is particularly common during an increase/decrease of the following single or multiple factors:
Big news that affect the general market or the single asset you are trading spike the volatility, which in turn increase the spread between the bid and ask of the traded instrument, which results in higher slippage. The higher the volatility the higher the slippage.
Liquidity can go down because of sudden news that affect the market in general or the single asset you are trading. The level of liquidity in financial markets can significantly impact trading outcomes. Low liquidity can make executing trades challenging and increase transaction costs. Traders must consider liquidity before entering into trades to minimize the risks associated with illiquidity. The lower the liquidity the higher the slippage,
Big trade size affect the liquidity of traded instruments. Imagine buying one million shares of a stock that trades one million shares per day. If you execute that trade at once, then you will get huge slippage with your trade. This can also happen with a liquid instrument, for example the flash crash of 2010 started with an error of trader/algo that tried to sell 65,000 emini contracts at once, when that showed up, bids started to pull out, and market started to drop which brought more sellers, and the cycle continued with disastrous results.
Nanex graph that shows how liquidity dry as the price goes down.
Below is a very interesting documentary that expose everything about the flash crash
Time of Day:
Other than the factors above, in normal markets slippage is mostly affected by time of day in relation to that instrument daily session time.
For example the open and the close of the New York session is usually volatile due to the pent up orders that needs to be filled which produce the highest slippage. Most active trading happen in the first two hours and the last hour of New York session which produce the lowest slippage numbers.
StatOasis VIP community video illustrating slippage per time of day
Today with a type 1 broker, most liquid instruments have a one tick slippage, and sometimes zero, Unless you are trading after hours or during lunch time (in relation to daily session time of your instrument) then you should factor 1 to 2 ticks of slippage per round trade.
That means you should always look for a strategy with an average trade of at least 2 times the commission and slippage cost to even consider it in your portfolio.