What Is Slippage and How to Mitigate It in Trading?

What Is Slippage in Trading?

Slippage refers to the phenomenon where there is a significant difference between the specified trading price given by a client and the actual execution price during a trade.

For example, if a client sees a quote for Bitcoin against the US dollar as 30,000.90 on a platform, and the market can accept a trading volume of 5 million US dollars at that price, but the client places an order for 6 million US dollars, what happens? In this case, 5 million US dollars will be executed at 30,001.00, while the remaining 1 million US dollars will be executed at the next available price, which could be 30,001.02 or higher.

Slippage is more common in fast-moving markets or markets with lower liquidity. When investors submit their trading orders, the market price may have already changed, resulting in a difference between the final execution price and the expected price. This difference can have an impact on the trading outcome, causing the price to be higher or lower, thus affecting profitability or losses.

Slippage can be either positive (price is lower) or negative (price is higher), depending on market conditions and the direction of the investor’s trade.

Causes of Slippage:

1. Market Volatility: Instantaneous price fluctuations in the market are a major cause of slippage. In highly volatile markets, prices can change frequently and drastically during the execution of a trade, resulting in slippage.
2. Insufficient Liquidity: Market liquidity refers to the quantity and size of buy and sell orders available in the market. When there are relatively fewer buy and sell orders in the market, the executed price may be influenced by smaller trading volumes, leading to larger slippage. Low liquidity markets are more prone to significant slippage, especially during large trades.
3. Execution Speed: The execution speed of a trade plays a crucial role in determining the magnitude of slippage. If the trading system or platform has slow response times or unstable network connections, it may result in execution delays, preventing investors from trading at their desired prices and causing slippage.
4. Excessive Trade Volume: When investors trade with large volumes, they may exceed the available best buy and sell order quantities in the market. As a result, investors may have to accept more unfavorable prices to complete the trade, leading to slippage.
5. Significant News Events: Major news events or market emergencies can trigger significant market volatility, resulting in slippage. In such cases, the speed of price movements in the market can be extremely fast, making it difficult for investors to trade at their expected prices in a timely manner.
6. Trading Strategies and Tools: Certain trading strategies or the use of specific trading tools can also contribute to slippage. For example, using market orders instead of limit orders is more prone to slippage during periods of high market volatility.

Common Methods to Mitigate Slippage:

1. Use Limit Orders: Limit orders allow you to specify the maximum buy price or minimum sell price for a trade. By setting appropriate prices, you can avoid being heavily impacted by slippage during market fluctuations.
2. Choose High-Liquidity Exchanges and Assets: Exchanges and assets with sufficient liquidity generally have more buy and sell orders and smaller bid-ask spreads, which helps reduce the occurrence of slippage.
3. Diversify Trade Volume: If you’re trading with a large volume, consider spreading your orders across different exchanges or time periods. This can help minimize the impact of slippage when executing large trades on a single exchange or at a particular moment.
4. Monitor Market Volatility and Important Events: Keep a close eye on market volatility and significant news events, especially those relevant to your trading assets. This allows you to anticipate potential market fluctuations and make informed trading decisions to mitigate the impact of slippage.
5. Use Stop-Loss Orders: Setting stop-loss orders can automatically execute trades when the market price reaches a predetermined stop-loss level. This helps avoid larger losses during market volatility.
6. Familiarize Yourself with Trading Tools and Platforms: Understand and become familiar with the features and functionalities of the trading tools and platforms you use, including order types, trading fees, execution speeds, etc. This enables better timing and execution of trades, reducing the occurrence of slippage.
7. Utilize Algorithmic Trading: Algorithmic trading allows for automated trade execution based on preset rules and parameters. By utilizing algorithmic trading, trades can be executed faster and more accurately, minimizing the impact of slippage.