Slippage is the execution of a market order at a price that differs from the expected values when the order was formed. With slippage, the trader receives a result that is not at all the one he hoped to get.
Slippage can occur when a stop-loss order (and other conditional orders) was not implemented. So the price goes beyond the limits of the set value and trades higher/lower, depending on the direction of the placed order. Another reason for slippage may be the actions of shady exchanges – this is pure fraud, but fortunately this is a rare situation.
Slippage is a typical thing for all markets, including the cryptocurrency one. This happens most often with low-liquid assets, and it is also very common on decentralized exchanges (DEX).
When does slippage occur?
Slippage occurs when the final price of a deal differs from what the trader expected. But it is not always a bad thing for traders. It can be negative and you may lose some money. But it also can be positive, because there is a chance of getting a better deal. So, for instance, you want to buy 100 coins each for $5 each, but the price of the asset drops to $4.50, then your order will be $450, not $500, which means you got a better deal. But if the price goes up, there will be a negative slippage. Imagine, that instead of $5 now the asset costs $5.50. In the end, you'll have to spend not $500 but $550.
Causes of slippage
If you know the cause of this phenomenon, it will be clear how to minimize the risks of getting a loss.
- Low liquidity
Liquidity is what makes it possible to buy and sell an asset without affecting the current price. The lack of liquidity in the traded pair is the main reason for slippage. Due to the fact that liquidity is not an absolute, but a relative value, a trader or investor is obliged to determine the presence or absence of proper liquidity in an asset. Even at the stage of planning a transaction, otherwise, there may be serious consequences.
- Gap in spread
Spread — the price range between the nearest order in the order book to buy and sell. The more liquidity in a pair, the smaller the spread, and vice versa. A significant spread says that there are few participants, as well as orders. While a market order is being formed, another order placed by other participant may be added to the spread. So a large order may be withdrawn and a slippage will occur. When there are many trading participants, several canceled orders will not affect the liquidity of the order book, and the spread will be minimal.
- High volatility
High volatility means there is a sharp price change in one direction or another – an aggressive growth or a big decline in the price of an asset. During periods of high volatility, there is a strong tension in the market, many participants can make transactions out of an emotional state. It increases the price movements.
Moreover, conditional orders, like stop loss or take profit, are usually placed near important price zones, which also increase the impulse price movements in one direction or another. Therefore, a newly created market order will compete for liquidity in the order book. If your market order gets ahead of another, you will open or close on the next available order.
How to avoid slippage
- Always evaluate liquidity before placing an order, especially if you are trading small altcoins and significant amounts. Incorrect assessment of liquidity at the time of planning a deal can be a big problem.
- Choose liquid assets and the most liquid platforms, then the chance of getting serious slippage is minimal.
- With using limit orders, you are safe from slippage, since this phenomenon does not occur with this type of orders.
- When using conditional order types, increase the gap to the maximum acceptable value so that the order is triggered by the market, and not sent to the order book to create liquidity.
Conclusion
Now that you learn about slippage, you can put that knowledge to good use. Theoretically, slippage can occur from time to time on any asset and exchange – the less liquid the pair, the more chances for it to happen. Be careful and do not get involved in deals with assets that have no liquidity at all. Probably, it is not wise to use this approach as the main trading strategy, because it happens rarely. But as an additional way to make money with minimal risks, this option can be considered, however take into account all the possible risks.
Have you heard about slippage in trading? Share your experience in the comments!
If you want to learn more interesting facts about crypto then check out our blog! You might like our articles “Overbought & Oversold: Signals for Crypto Traders” and “Zero-Knowledge Proofs on Bitcoin”.
