In the trading world, it's not rare for individuals to observe that their trade orders don't always match the expected price. This phenomenon, known as "price slippage," can sometimes result in orders executing at a higher or lower price than expected. The primary culprits behind slippage are the market's inherent volatility and the liquidity of the traded assets.
What is slippage in pricing?
Price slippage occurs when a trader's order is filled at a price different from the one they initially asked for. This typically happens in fast-moving markets where values can shift rapidly. Markets that are highly volatile and subject to quick changes in trends are more susceptible to slippage.
So, What Exactly Triggers Slippage?
When you initiate a trade, you expect it to be executed at a certain price. Yet, due to market fluctuations, the final price might differ. This difference can be advantageous or disadvantageous. For instance, if you aim to buy a digital asset for $100 but acquire it for $98, you've benefited from positive slippage. Conversely, if it costs you $102, you've encountered negative slippage.
What is an example of slippage?
A 2% slippage indicates that an order is filled at a price that is either 2% higher or lower than the anticipated price. For instance, if you intended to buy shares at $100 each but actually bought them at $102 each, this is an example of a 2% negative slippage.
Factors Leading to Slippage
- Volatility - Every financial market is known for its price swings. Supply-demand dynamics, market sentiment, regulatory news, and overall enthusiasm can cause rapid price changes.
- Liquidity Issues - Some digital assets aren't widely traded, leading to low liquidity. When buyers or sellers are scarce, even a large order can shift the market price.
What is money slippage?
Slippage is the discrepancy between the expected price of a trade and the actual price at which the transaction occurs. It can occur at any time but is most commonly observed during periods of high market volatility and when market orders are in use.
The Concept of Slippage Tolerance
Traders can set a "slippage tolerance" to control their exposure. It's a percentage indicating how much price deviation they will accept. For instance, with a 3% tolerance on a $100 order, the trader is comfortable with a price between $97 and $103.
However, a high tolerance can expose traders to "front-running," where malicious actors exploit the trader's willingness to accept a higher slippage.
Minimising Slippage
- Use limit orders - Unlike market orders that execute at the best available price, limit orders set a specific price, reducing slippage chances.
- Trade in stable markets - Avoid trading during major announcements or events that induce volatility.
- Opt for liquid assets - More liquid cryptocurrencies are less susceptible to significant slippages.
Final Remarks
Trading is full of surprises, and sometimes, these surprises are not so pleasing. One of these is slippage, but with careful risk management and research, you can minimise its occurrence and safeguard your investments.