What is Slippage in Trading?

Imagine you’re trying to buy a specific stock for $50. You place your order, expecting to get it at that price. But by the time your order is actually filled, the price has gone up to $50.05, or perhaps gone down to $49.95. That small difference between the price you expected and the price you actually got is slippage. It’s a common part of trading, especially in fast-moving markets, and understanding it is vital for any trader.

What Causes Slippage?

Slippage occurs because the financial markets are incredibly dynamic and constantly changing. Several factors contribute to this phenomenon:

Market Volatility

When markets are volatile, meaning prices are changing rapidly, slippage is more likely. Large price swings in short periods make it harder for your order to be filled precisely at your desired price.

Order Type

Different order types have different susceptibility to slippage. Market orders, designed to be executed immediately at the best available price, are more prone to slippage than limit orders, which are filled only at the specified price or better. Limit orders might not get filled if the market moves beyond the limit before the order can be executed.

Order Size

Large orders can create greater slippage because they require liquidity, meaning a significant number of buyers and sellers, to be satisfied. If there aren’t enough shares available at your desired price, the order might be filled at several different prices, resulting in slippage.

Market Liquidity

Liquidity, or the ease with which an asset can be bought or sold without affecting its price, directly impacts slippage. In less liquid markets, price gaps can occur quickly, making it difficult to fill orders at the specific price you intended.

Trading Platform Speed

The speed of execution on your trading platform can affect slippage. A slower platform might mean orders arrive after other orders have shifted prices, leading to increased slippage.

Positive vs. Negative Slippage

Slippage can be either positive or negative. Negative slippage is when you get a worse price than anticipated (buying higher, selling lower). Positive slippage, conversely, means you get a better price (buying lower, selling higher). While positive slippage is advantageous, it’s important to note that this isn’t something traders usually rely on when making trades; most usually factor in a level of potential negative slippage.

Slippage in Different Markets

Slippage is not exclusive to the stock market. It can occur in almost any market including:

  • Forex: Currency markets are known for higher volatility, which can result in noticeable slippage.
  • Cryptocurrency: The cryptocurrency market has wild price swings, making slippage a very real risk.
  • Commodities: Similar to stocks, commodities trading can also experience slippage, especially during periods of high activity.

How to Manage Slippage

While you can’t totally eliminate slippage, you can take steps to manage the risk:

  • Use Limit Orders: Limit orders ensure your order is filled only at the specific price you set, avoiding any worse price. Note that it may not be filled if it’s priced too far away from the current market price.
  • Trade During High Liquidity Hours: These often align with when major exchanges are open, as there will likely be many buyers and sellers.
  • Avoid Trading During Volatile Times: News events often cause more sudden price movements, which can increase slippage.
  • Choose a Good Broker: Some brokers offer faster execution speeds which help minimize slippage. Research them to see what their speed and accuracy is like.
  • Split Large Orders: Divide a large order into smaller ones, which can help reduce the impact of slippage.
  • Use Tools and Platforms with Price Tracking: Some trading platforms can detect if slippage is occurring and adjust your order accordingly.

Slippage and Trading Strategy

Understanding how slippage interacts with your trading strategy is key to long-term success. For example, if you are using a strategy that focuses on scalping (making many small trades in a short amount of time) it may be more prone to slippage due to the volume and speed of trades. Day traders also need to be mindful of slippage for the same reasons. Position traders, who hold trades over longer periods, may be less affected by slippage, but it should still be accounted for.

Conclusion

Slippage is a fundamental aspect of trading that traders need to understand and accept as a part of the process. It arises due to market dynamics, order types, and overall liquidity. While negative slippage can impact profitability, positive slippage is not always something traders can rely on. Successfully managing slippage involves selecting appropriate order types, trading during optimal hours, and choosing technology which can reduce slippage. By acknowledging and accounting for slippage, traders can make better informed decisions to support a more profitable trading journey.

Frequently Asked Questions (FAQ)

What is the difference between slippage and spread?

Slippage is the difference between the expected price of an order and the price it’s actually filled at. The spread is the difference between the bid (the highest price a buyer is willing to pay) and the ask (the lowest price a seller is willing to accept). They are both results of market mechanics, but are distinct concepts.

Is slippage good or bad?

Slippage can be either positive (getting a better price than expected) or negative (getting a worse price). However, most of the time traders should be factoring in the risk of negative slippage into their trading strategies.

Can I avoid slippage altogether?

No, it’s almost impossible to completely avoid it. However, you can manage the risk by using strategies and avoiding high volatility periods by employing the mitigation techniques outlined above.

Is slippage the same on all trading platforms?

No. Different platforms have varying execution speeds and access to liquidity pools which leads to varied levels of slippage. It’s important to research your chosen platform’s processing capabilities.

What is percentage-based slippage?

This is simply slippage expressed as a percentage of the total trade. It is a way to compare slippage across different trade sizes, prices, and market conditions.

Should I use Market or Limit orders?

Market orders are designed to be executed immediately at the best available price, making them highly susceptible to slippage. Limit orders can guarantee the specified price (or better), but might not get executed if the price is not reached.

How can I track the slippage of my trades?

Most trading platforms offer tools and features that can help traders track the level of slippage that occurs on their orders. You can also estimate it by comparing order prices vs. filled prices on your trades.

References

  • Investopedia: Slippage
  • Babypips: What is Slippage?
  • Corporate Finance Institute: Slippage

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