Slippage refers to the difference between the expected price of a trade and the price at which the trade is executed. Slippage can occur at any time but is most prevalent during periods of higher volatility when market orders are used. It can also occur when a large order is executed but there isn’t enough volume at the chosen price to maintain the current bid/ask spread.
Key Insights
- Slippage refers to all situations where a market participant receives a different trade execution price than intended.
- It occurs when the bid/ask spread changes between the time a market order is requested and when it is executed.
- Slippage happens across various markets, including equities, bonds, currencies, and futures.
- Execution price differences can be categorized as positive slippage, no slippage, or negative slippage.
- Slippage can be limited by preferring limit orders, investing in calm markets, and avoiding trades late in the day.
How Does Slippage Work?
Slippage does not denote a negative or positive movement because any difference between the intended and actual execution price qualifies as slippage. When an order is executed, the security is purchased or sold at the most favorable price offered by an exchange or other market maker. The final execution price can lead to results that are more favorable, equal to, or less favorable than the intended execution price.
Market prices can change quickly, which allows for slippage during the delay between when a trade is ordered and when it is completed. Definitions of slippage are consistent across various market venues but tend to occur in different circumstances. A limit order prevents negative slippage but risks non-execution if the price does not return to the limit level. This risk increases with rapid market fluctuations, reducing the time to complete a trade at the intended price. To avoid negative slippage, place limit orders.
Example of Slippage
One common way slippage occurs is through abrupt changes in the bid/ask spread. A market order may get executed at a less or more favorable price than intended. For instance, if Apple’s bid/ask prices are posted as $183.50/$183.53 on a broker’s interface. A market order for 100 shares is placed with the expectation of an $183.53 fill. However, micro-second transactions by computerized programs lift the spread to $183.54/$183.57. The order gets filled at $183.57, incurring $0.04 per share or $4.00 per 100 shares of negative slippage.
Slippage and the Forex Market
Forex slippage happens when a market order is executed, or a stop-loss ends the position at a different rate than set. Many traders use stop-loss orders to limit potential losses; an alternative is using option contracts to limit exposure during fast-moving markets. Slippage in the forex market is more likely when volatility is high due to news events or during trading outside peak market hours.
How to Reduce the Impact of Slippage
While slippage is a part of investing, there are strategies to avoid or limit its impact. Due to the volatile nature of markets, trade timing and the type of security traded can play a significant role.
Trade in Calm Moments
Less volatility means less chance of getting caught by slippage. Avoid investing around major economic announcements or important security updates such as earnings reports, as these can lead markets to move significantly.
Place Limit Orders Instead of Market Orders
Market orders are executed as quickly as possible while limit orders only go through at a specified price or better. With a limit order, you can avoid negative slippage, though there’s a risk of the order not being executed. Some platforms allow placing orders with a specified maximum slippage tolerance.
Slippage in Cryptocurrency Markets
Slippage impacts all asset classes, including crypto, which tends to be more volatile and, in some instances, less liquid.
What Is a 2% Slippage?
A 2% slippage means an order is executed at a price 2% more or less than expected. For example, an order placed for company shares trading at $100 might execute at $102 with 2% negative slippage.
Is Positive Slippage Shocking?
Yes, positive slippage is beneficial as it means receiving a better price than expected.
Conclusion
Slippage is undeniably a part of investing. As orders are fulfilled, bid/ask spreads may change, leading to differences in execution prices. This occurs across all markets, particularly during volatile or less liquid periods. While generally minimalized in markets filled with liquidity and consistent price movement, slippage can still offer positive or negative results. Positive slippage returns a better-than-expected price, while negative slippage has the opposite effect.
Related Terms: market volatility, market prices, stop loss, limit orders, financial trading.
