Slippage refers to the difference between the expected price of a trade and the price at which the trade is executed.
This can occur in any market, but it is most common in volatile markets where prices change rapidly.
Key aspects of slippage:
Causes of slippage
1. Market volatility
When the market is volatile, prices can fluctuate rapidly between when an order is placed and when it is executed.
This can lead to slippage, as the actual execution price may differ from the expected price.
2. Liquidity
Limited liquidity for a particular asset can make executing a trade at the desired price difficult.
This is because there may need to be more buyers or sellers willing to trade at that price.
3. Order type
Market orders are more likely to experience slippage than limit orders.
This is because market orders are executed at the best available price, which may differ from the desired price.
Limit orders, on the other hand, specify a maximum price that the trader is willing to pay or a minimum price that they are willing to accept, which can help to limit slippage.
Types of slippage
1. Positive slippage occurs when the execution price exceeds the expected price.
For example, if you place a market order to buy an asset at $10 and the actual execution price is $9.95, you have experienced positive slippage.
2. Negative slippage occurs when the actual execution price is worse than the expected price.
For example, if you place a market order to sell an asset at $10 and the actual execution price is $9.95, you have experienced negative slippage.
Impacts of slippage
1. Increased transaction costs
Slippage can increase the cost of trading, as traders may end up paying more than they expected for an asset or receiving less than expected for an asset they sell.
2. Reduced profitability
Slippage can reduce the profitability of trading, as it can eat into potential profits.
3. Market inefficiency
Slippage can indicate market inefficiency, indicating that the market cannot always match buyers and sellers at the desired price.
Strategies to minimize slippage
1. Use limit orders
Limit orders allow you to specify the maximum price you are willing to pay or the minimum price you are willing to accept for an asset.
This can help reduce slippage, as the order will only be executed if the market price reaches your limit.
2. Trade during periods of low volatility
During periods of low volatility, the market is less likely to experience sudden price swings.
This can help to reduce the risk of slippage.
3. Trade on exchanges with high liquidity
Exchanges with high liquidity have many buyers and sellers, making executing trades at the desired price easier.
4. Use stop-loss orders
Stop-loss orders can help to limit your losses if the market suddenly moves against you.
This can help to protect your capital and reduce the risk of slippage.
In conclusion, slippage is a common occurrence in trading, and it is important to be aware of the factors that can cause it and the strategies that can be used to minimize its impact.
By understanding the risks, traders can make more informed decisions and protect their capital.