Slippage

Slippage is among the most misunderstood yet common and efficient aspects of trading. Slippage is essential to consider when managing risks and making informed decisions while trading stocks, forex, or cryptocurrencies. This guide will look deeper into the types of slippages, their causes, and how they affect various trading scenarios. From market orders to limit orders, explain well how slippage happens and what traders can do to soften the blow. By the end of this article, you will have a solid foundation to confidently address slippage in your trading strategy. 

What is Slippage? 

Slippage refers to the difference between the supposed price of a trade and the actual price on the execution of the said trade. It happens because of an interlude between placing an order and executing it due to market action. It’s more associated with market orders, ensuring that trades go through at the best price. As a result, the price at which a trader intends to buy or sell an asset may no longer be available when the order is processed. 

Understanding Slippage 

Slippage in trading occurs at different times, particularly during high volatility or when the market is illiquid. A situation where the trader intends to enter an order and the price changes before the execution may result in a price different from the actual execution. It may be observed in any financial market, such as stocks, forex, and cryptocurrencies.

Slippage occurs when the actual execution price of a trade differs from the intended price. It is common in turbulent markets and can significantly affect a trader’s profitability. Market orders are highly prone to slippage, as they are filled at the best price available at the time, probably different from what was expected.  

On the other hand, limited orders allow traders to name their price when either buying or selling. That minimises the chances of slippage, although it may not get filled if the market price doesn’t achieve the set limit.  

Slippage can be expected during volatile markets or when trading in large volumes because rapid price changes or low liquidity levels may cause trades to be executed at less favourable prices. Also, traders need to be informed about these conditions and select appropriate types of orders to ensure the efficiency of trade execution. 

Types of Slippages 

Slippage can be classified into several types, depending on the nature of the trade and prevailing market conditions: 

1. Negative Slippage occurs when a trader pays more than he expected for a buy order or receives less than his expectation on executing a sell order. For example, in placing a market order to buy a stock at US$50, if the order gets filled at US$52 due to rapid price increases, that becomes a negative slippage of US$2.

3. Positive Slippage: Slippage is positive when the trader has benefited from a better price than expected. For instance, when he wants to buy at US$50 but gets filled with $48 because the price suddenly dropped, hence a positive slippage of US$2.
4. Zero Slippage: This is a situation where the order executes at the exact price anticipated. A good example is when a trader places a buy market order on stocks at US$ 50 and gets filled with a cost at the same price, hence zero slippage.

Causes of Slippage 

There are several causes of slippage in trading. Each factor determines whether the trades get executed at the intended prices. 

1. Market volatility: It is one of the leading causes of rapid price movements at times, caused by such events as earnings reports, economic announcements, or geopolitical developments, resulting in trades being executed at unexpected prices.

2. Low liquidity: This is another major factor. With fewer buyers or sellers in the market, it may not be accessible during times of low trading volume to have sufficient orders at the intended price level, which results in less compelling execution prices.

3. Order size: This also affects slippage in that a large trade may have to be filled at various price levels since the market might not provide the liquidity needed to fill such an order at one price level.

4. Timing of the day: It can lead to slippage. Market opening or closing timing typically demonstrates high volatility and poor liquidity in the market. 

The constituents mentioned above are crucial for a trader to learn to minimise slippage and maximize profit by adopting different approaches in different market conditions. 

Examples of Slippage 

To illustrate, the following are some practical examples of slippage: 

1. Example of Market Order: A trader wants to buy 1,000 shares of a stock at US$100. Due to high demand, the order is filled at an average price of US$102. It leads to a negative slippage of US$2 per share and costs the trader an extra US$2,000.

2. Positive Slippage Example: When a trader places a market order to sell a cryptocurrency at US$1,000 and gets an execution at US$980 because of the sudden price drop, it creates a positive slippage of US$20, meaning that the trader benefits.

3. Example of Limit Order: A trader places a limit order to buy a stock at US$50. If the stock does not attain that value but jumps up to US$55, the trade is not executed, avoiding any slippage and possibly missing the trade.

Frequently Asked Questions