Slippage

How slippage works

When a trader places a market order to buy or sell an asset, the order is executed at the best available price. However, in fast-moving markets, the price at which the order is executed might differ from the price at which the order was placed. This difference is known as slippage. Slippage can be positive or negative, depending on the direction of the price movement:

Positive slippage: Occurs when a buy order is executed at a lower price than expected, or a sell order is executed at a higher price than expected.

Negative slippage: Occurs when a buy order is executed at a higher price than expected, or a sell order is executed at a lower price than expected.

Factors contributing to slippage

Market volatility

High volatility increases the likelihood of slippage. In volatile markets, prices can fluctuate significantly in a short period, making it difficult to execute orders at the requested prices.

Liquidity

Liquidity refers to the ease with which an asset can be bought or sold without affecting its price. Low liquidity can lead to higher slippage as there may not be enough buyers or sellers to execute the order at the desired price. In contrast, highly liquid markets tend to experience less slippage.

Order type

The type of order placed can also influence slippage. Market orders, which are executed immediately at the best available price, are more susceptible to slippage compared to limit orders, which specify the maximum or minimum price at which a trader is willing to buy or sell. Limit orders can help mitigate slippage but may not be executed if the market price does not reach the specified limit.

Managing and minimizing slippage

Use of limit orders

Traders can use limit orders to specify the maximum price they are willing to pay for a buy order or the minimum price they are willing to accept for a sell order. This strategy helps ensure that the order is executed only at the desired price, reducing the risk of slippage.

Trading during high liquidity periods

Traders can minimize slippage by executing trades during periods of high liquidity. Major financial markets typically have higher liquidity during regular trading hours, reducing the likelihood of significant price movements between order placement and execution.

Avoiding volatile markets

By avoiding trading during periods of high volatility, traders can reduce the risk of slippage. Monitoring market conditions and news events can help traders identify times when markets are likely to be more stable.

Monitoring spreads

The spread, which is the difference between the bid and ask prices, can provide insights into market conditions. Wider spreads can indicate higher volatility and lower liquidity, increasing the risk of slippage. Traders can monitor spreads to better time their trades and reduce potential slippage.

Examples of slippage

Cryptocurrency markets

In cryptocurrency markets, slippage is frequently experienced due to the high volatility and lower liquidity compared to traditional financial markets. For example, if a trader places a market order to buy Bitcoin during a significant market move or news event, the price may change rapidly, resulting in the order being executed at a different price than initially anticipated. Additionally, during large buy or sell orders, especially for less liquid cryptocurrencies, the lack of available orders at the desired price can cause substantial slippage.

Stock markets

In stock markets, slippage can occur during periods of high volatility, such as earnings announcements or economic data releases. For example, if a trader places a market order to buy shares of a company immediately after an earnings report, the rapid price movement can result in the order being executed at a different price than expected.

Forex markets

In the forex market, slippage is common during major economic announcements, such as interest rate decisions or employment reports. These events can cause significant price swings, leading to slippage for traders who place market orders during these times.

Final thoughts

Slippage is an important consideration for traders in volatile markets. By understanding the factors that contribute to slippage and employing strategies to manage it, traders can mitigate its impact on their trading outcomes. Using limit orders, trading during high liquidity periods, and avoiding volatile markets are effective ways to minimize slippage and achieve more predictable trading results.