What is Slippage in Trading
Traders don’t want to see too much movement in the trades they place, as this can affect the bottom line of their executed trade. Slippage is the difference in the executed price from the actual stock (or asset) price the trader expected.
Since slippage results from the movement in the market toward either a strong uptrend or a downtrend – the odds of slippage in your trade having a positive impact is undoubtedly there. Still, there is also a chance that it can negatively affect your portfolio. Slippage occurs in all markets, including equities, bonds, currencies, futures, and cryptocurrencies. Still, it can be a costly circumstance which is why we want to go over how to calculate and avoid it.
How to Avoid Slippage
Traders refer to slippage either as negative or positive, resulting from market orders. A small amount of slippage in a well-traded market is considered normal. However, you want to keep it at a manageable level. Utilizing a limit order can help prevent it, ensuring the trade only executes at the designated price.
Most trading platforms offer these five types of orders:
- Market order
- Limit order
- Stop order
- Stop limit
- Trailing stop
Other ways traders can prevent slippage:
- Buy limit order is a limit order to buy at a specific price.
- Sell stop order is a stop order to sell at a market price after a stop price has been reached.
Slippage occurs when two things coincide in the market: low liquidity and high volatility. When there aren’t many buyers in the market, traders may not get the price they anticipated.
Remember that a limit order is not guaranteed to be executed, as it will not be complete until the stock or asset reaches the specified price level. In the case of a sell stop order, a trader sets a stop price to sell. A market order to sell is triggered if the stock moves to the stop price.
Slippage can occur during market close, as overnight trading can affect the opening price. But, it can occur during the market hours, as well. A global or market event can trigger slippage. A major FOMC announcement, earnings report, or news can further be heightened.
When the market is amid a sell-off, the low numbers of buyers aren’t balancing the market. This lack of enthusiasm can lead to significant volatility in shares of an impacted company. Bad news can result in a loss of confidence in company projections, a change in economic support, or a change in investor sentiment. Caused by intense selling and buying, slippage leads to stock prices that incur quick movements up or down abruptly. This is generally due to large institutional investors or market makers exiting or entering a position with a stock when there isn’t enough volume at the selected price to maintain the current bid/ask spread.
For example, suppose an institutional investor buys many shares in a company. In that case, the large buy order moves the price upward and causes significant upward pressure.
Slippage can occur when an institutional investor, or a major stockholder, sells a large number of shares. Should the “market makers” begin selling shares when the share price has appreciated, retail traders’ rush to sell will cause the price to tumble unexpectedly. This selling pressure causes stock prices to move quickly in the other direction (forwards or backward) and can be significant. Traders should monitor the market’s liquidity and volatility with their trades.
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How to Calculate Slippage
The most common type of slippage is negative, where the position gets filled at a worse price than expected. However, there can be a positive slippage where an order gets filled at a better price than expected.
It’s straightforward to calculate slippage in any market. Traders calculate it by calculating the difference between the executed stock price and the anticipated stock price.
Another way to calculate slippage is by calculating the difference between the highest bid price and the lowest ask price – which is the bid-ask spread. If the highest bid price is $100 and the lowest ask price is $105, the bid-ask spread would be 5%.
To calculate the slippage, you should learn how to calculate its percentage and dollar amount. To calculate the exact percentage, traders must first have the dollar amounts. Here is an easy formula to calculate the percentage of slippage.
Percentage Slippage = $ of Slippage / (LP – EP) x 100
- LP shows the Limit Price
- EP shows the Expected Price
In a trade, the percentage of any measurement is used. So, it’s necessary to calculate the percentage slippage in the crypto market.
What Does Low Liquidity Mean in Crypto?
Low liquidity means fewer buyers or sellers placing trades in the crypto market. When this happens, the market can be a risky place. The cost of buying or selling increases, and traders sometimes cannot exit trades.
If you believe the price will increase soon, you might consider waiting before purchasing or selling the cryptocurrency you hold in your trading account. If your strategy indicates high volatility in the market, you might not want to hold onto your crypto until a trendline begins to form.
A crucial factor that can help traders determine how much liquidity a cryptocurrency has relative to other cryptocurrencies. Cryptocurrency has a large market capitalization relative to its total supply.
What Does the Position Effect Mean in Trading?
Positional traders often attempt to capture the most profitable area of an asset’s movement when it is in a long-term trend. Most assets follow a pattern where they see a movement in price led by a significant change in underlying fundamentals. Traders looking for opportunities to shorten the market can take advantage of slippage amidst the high volatility trending market. A position effect impacts a trader’s account performance because the equity account is either long or short.
The position effect can be:
A favorable position effect arises when the trader is trading long (a buy) in a rising market. A negative position effect occurs when the trader is shorting a trade in a falling market. The zero position effect happens when there are no long or short positions in an account. Any performance that is not attributed to rising or falling underlying asset prices is a position effect. Some assets remain dormant for a long period before moving. Changes generally lead to this movement in the company or industry fundamentals.
What Does Slippage Mean in Crypto?
Slippage in crypto refers to the price difference between expected trade execution and the actual trade. A cryptocurrency slippage occurs when the price of an asset moves beyond its most recent trading range and outside a specified percentage from the previous day’s trading range.
Slippage can also happen when one crypto-currency trades at a higher price than another on an exchange without any direct correlation between their values.
The cryptocurrency slippage is a function of the time and the amount of trading volume in the relevant markets. Slippages tend to happen at significant events. For example, when a cryptocurrency crosses a critical level, such as its all-time high, it will gain a slippage percentage due to the price action on that event.
Traders simply take the expected price that you want to enter at and subtract the actual trade entry price. Below is an example of this calculation:
Expected entry price: $10,000
Actual entry price: $9,950
Calculation: $10,000 – $9,950 = – $50
In this calculation, our negative slippage is $50.
Some of the same reasons traders experience slippage with stock trades occur with cryptocurrency: volatility, liquidity, internet connection, or big market players. Too much slippage for a high-quality crypto exchange should not be accepted.
Traders can combat all factors contributing to slippage by not selecting a digital coin that has increased volatility. Consider trading a different coin if a digital currency is experiencing increased volatility. Considering low liquidity in the market, consider using a different broker.
What Does Slippage Tolerance Mean?
Slippage tolerance can be adjusted on a trading platform at any time. This can vary depending upon how much “wiggle room” a trader has with the resulting stock or digital currency price. In the “Slippage Tolerance” settings, traders can choose a pre-set percentage or manually enter a custom percentage.
Suppose a trader is invested in an exchange that is down by 20% slippage for the month. A trader may wait for this position out in hopes the market will improve. If your trading plan allows you to see if the platform will recover to the state it was before the slippage, you may not be willing to tolerate anything over the 20% loss. Understanding risk strategy is essential as it can significantly influence overall trading success. Traders should know how many slippages they can tolerate trading successfully.
What is a Good Slippage Tolerance?
A conservative tolerance might be 1% for some traders. Traders should not consider trades that could cause them to lose more than 20% of their trading account – or even a day.
Many traders place their risk tolerance, which includes slippage, at 5% at any given time.
The key to sticking with your trading plan is calculating your risk tolerance ahead of time. Traders should always know where they stand when trading. They can then make decisions accordingly and minimize the effects of slippage on their trades.
What is Slippage in Trading Stocks?
Traders usually experience the most slippage around significant news events. Day traders should specifically avoid trading during major news events, FOMC announcements, or during that company’s earnings report.
Getting in and out may prove difficult until the announcements have been made. Insufficient liquidity is a common reason traders experience slippage at these times. These can lead to a gap between the executed stock price and the actual price at which a trade occurs.
Lower order volumes result in trades more likely to trigger stop losses or other automated trading orders resulting in slippages. With forex trading, this difference can occur even when there are similar amounts of buy and sell orders for any given currency pair.
Slippage Affects the Bottom Line
Slippage is a risk that all traders should be aware of in their trading careers. Regardless of which market you trade, it will be one of the significant issues within a particular market. The digital currency market is not an exception to the issues that cause high or low slippage.
Traders may consider waiting to place trades after the morning volatility until noon. Traders may find that afternoon trading hours are less volatile than the morning hours; hence this may be a more efficient trading time.
Mondays tend to have more market volatility versus the middle of the week – or even Monday afternoon. Events that move the broader market also can increase volatility. Major news events can cause high volatility, and the biggest slippages occur when major financial announcements are being made. Avoid placing market orders when market-shaking news is scheduled.
While you may not be able to avoid slippage altogether, considering the market and cryptocurrency volatility can help traders determine whether the risk of slippage is worth making the trade at that time. Traders should be aware of their slippage tolerance before entering a trading position allowing them to take advantage of the market. Slippage can be a tricky concept to understand, but if you still have questions about it, consider joining Simpler Trading in the Simpler Free Trading Room. Where traders can gain access to our trading room and the free classes that we offer. Sign up today, and never trade alone again.
FAQs on Slippage
A: Slippage can occur in all markets, including stocks, futures, and cryptocurrencies – but is more common in crypto markets.
: Slippage can happen during both the open market hours as well as after hours. When traders hold positions after the markets close, they can experience it when the market reopens. This can happen due to news events or announcements while the market is closed.
A: Traders employ guaranteed stops and limit orders to ensure that an order with a guaranteed stop will be executed at the requested price. A premium is attached to the guaranteed stop if it is triggered. When a limit order is activated, the order will be filled at the specified price or a favorable price. A limit order is the execution of a sell order that takes place at the specified price or a higher one. The execution of a buy order takes place at the specified price or a lower price.
A: No. Sometimes traders have a positive slippage which results in a better-executed price than expected, while a negative leads to a loss.
A: Certain market environments are more susceptible to slippage. To reduce exposure to risk when trading, traders should avoid trading when liquidity is low and volatility is high. Traders should strive to trade during hours of highest market activity and in low volatility markets.