Slippage

Slippage is a financial term that is used to refer to a situation where an order is not executed at the price indicated in the order. In this case, the actual price may be either better or worse than the price that was transmitted to the broker.

If the price turned out to be better, then the trader will receive additional profit, if the price turned out to be worse, then the trader will incur additional unintended losses that will increase the loss or reduce the profitability of the entire transaction.

The amount of slippage in trading varies widely — from a few units to hundreds of pips. The amount of slippage will depend on various factors, primarily on current liquidity and volatility, and on the type of orders submitted earlier.

How Does Slippage Occur?

Slippage occurs when executing stock orders. As we know, there are three main types of orders on the stock exchange:

• Stop order.
• Market order.
• Limit order.

The difference between them lies in the technology of their execution.

The trader places a limit order to buy or sell assets at a better market price than the current one. Such an order will be executed only when the required price appears. And this price will be equal to the one set by the trader.

A market order works as follows: a trader buys/sells assets at current market prices, concluding a deal on the terms of the closest opposite limit order. If the volume stated in it is sufficient to satisfy the market order, the position will be opened at the price of the limit order. If the volume of the market order exceeds the opposite limit order, limit orders from the order book will be executed in sequence. In this case, it is not necessary that their prices match those listed in the first order. In this situation, a market order can be executed at the price of the closest opposite order or even at a worse price. The worst price is the weighted average when there is a large number of opposite orders. This is called slippage — a price shift.

When a stop order is executed, slippage occurs in the same way as buying at market prices. There is another slippage scenario. The trader placed a stop order and indicated the execution price, but there is simply no limit order at that price on the market and it will not appear. In this case, when market quotations change, the order will be executed at the closest available limit order, which may be a worse price. In this case, we will also see slippage.

Let’s summarize. For a limit order, slippage is almost never typical, and it can be encountered mainly during market trading or during the execution of a stop order.

For a stop order, the price will generally be worse than the one indicated by the trader, and this will lead to unplanned losses.

For some of them, the price may be better than stated, which will be positive slippage during the opening. In theory, positive slippage can also occur when opening market orders, but only when executed at the market price.

For example, a trader issues an order to purchase shares of company A at the current market price of $100 per share. While the order reached the broker, the share price dropped, and a limit order for $99.50 appeared. Both orders will be satisfied, the trader with the market order gets the best price, resulting in positive slippage.

What Can Affect Slippage

Slippage depends on a number of factors, for example:

• The type of order (discussed above, which of them causes slippage). Of course, for a limit order, slippage occurs quite rarely, and it often turns out to be positive.
• Slippage often occurs at market openings and with stop orders. In these two cases, there is usually negative slippage.
• Market volatility. The greater the volatility, the higher the probability and magnitude of slippage. Slippage is more often encountered by traders who work with crypto and forex markets.
• Liquidity. Thinning of the order book is associated with a decrease in available liquidity and, as a result, with an increase in the probability of significant slippage. Slippage also occurs during trading with low-liquidity assets.
• The speed of delivery and execution of orders. High price dynamics, even a few seconds of delay, can lead to slippage.

The remaining factors can be considered as additional causes of slippage, related to the main ones listed above.

How to Protect Yourself From Slippage

As you have already understood, slippage often turns out to be negative; a trader needs protection in order not to incur additional losses, which can be done as follows:

• Stop using market orders and stop orders.
• Avoid entering transactions during market openings and closings and during news releases.
• Split large orders into smaller ones to reduce slippage risk, since larger orders are more sensitive to price changes.
• Take costs into account. You can estimate the average slippage cost. Losses from slippage should be considered along with broker and exchange fees, withdrawals, etc.

In general, slippage has almost no effect on the profitability of traders and investors who work in long-term trading. In medium-term trading, slippage is critical. Scalpers and day traders should definitely consider the negative effects of slippage.