Slippage
Slippage is a very common phenomenon in trading that everyone should be aware of. It is the difference between the expected price of a trade and the actual price at which the trade is executed. Slippage can occur in all types of markets such as stocks, futures, forex and cryptocurrencies.
Types of Slippage
Slippage can be of two types, positive and negative
- Positive Slippage: This occurs when your trade is executed at a better price than the expected price. For example, you want to buy a stock at $10 and it gets executed at $9.80. This is also called price improvement.
- Negative Slippage: This occurs when your trade is executed at a worse price than the expected price. For example, you want to buy a stock at $10 and it gets executed at $10.20. This can happen due to high volatility, low liquidity, or slow order execution.
Causes of Slippage
Slippage can be caused by various factors such as:
- Volatility: High volatility can increase market movements and change prices quickly.
- Liquidity: Low liquidity can cause difficulty in executing orders resulting in higher slippages.
- Order Execution: The speed of order execution can also cause slippage.
- Market Depth: Market depth refers to the number of buy and sell orders at different prices. Lesser market depth can cause higher slippage.
- News: Major announcement or news can cause sudden volatility and slippage.
Impact of Slippage
Slippage can have a significant impact on your trading results. Positive slippage can increase your profits, while negative slippage can increase your losses. It is essential to consider slippage while calculating the risk-reward ratio of a trade. High slippage can also cause a reduction in the returns of a trading strategy.
How to Reduce Slippage?
Slippage cannot be entirely eliminated, but it can be reduced by following strategies:
- Use Limit Orders: Limit orders specify the maximum price you are willing to buy or sell an asset. It ensures that your trades are executed at the expected price or better.
- Trade During Liquid Hours: Trading during high liquidity hours can reduce slippage as there will be enough buyers and sellers in the market.
- Use Market Orders only during High Liquidity: In times of high volatility, using market orders can cause higher slippages. It is better to stick with limit orders.
- Use Fast Order Execution Services: The speed of order execution can impact slippage. Using a broker that offers fast order execution service can reduce slippage.
Conclusion
Slippage is a prevalent phenomenon of trading that cannot be entirely avoided, but it can be managed. It is essential to consider slippage while calculating risk-reward ratio and evaluating the performance of a trading strategy. Traders and investors should follow above-discussed strategies to reduce slippage and maximize their profits.