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Slippage: what is it and how to avoid it?
Slippage, in the context of financial trading, refers to the difference between the price at which a trader expects to execute a trade and the price at which the trade is actually executed. This often occurs during times of high volatility or when large orders are placed in a market where there is not enough buying or selling volume to maintain the expected price.
But this concept goes beyond that, and for that reason we leave you with this article that will unpack this concept so that you will be ready when this event happens.
What is Slippage?
Slippage is a financial term that refers to the difference between the expected price of a trade and the actual price at which the trade is executed. It occurs when market orders are placed during periods of high market volatility and when large orders are placed when there is not enough buying interest in the asset to maintain the expected price of the trade.
Slippage (as it is also called in Spanish) can be positive or negative. Positive slippage occurs when the strike price is more favorable than the expected price, while negative slippage occurs when the strike price is less favorable than the expected price.
What does Slippage produce?
When trading, slippage can occur if a trade order is executed without using a limit order, or if a stop loss is placed at a less favorable price than initially set. This phenomenon often occurs during periods of high volatility, such as in the case of news that significantly impacts the market, which can make it difficult to execute orders at the expected price.
In such situations,traders usually accept that their trades will be executed at the next best available price, unless they have a limit order that places a stop at a predefined price level.
In trading stocks, CFDs or perpetual contractsslippage is related to changes in the spread, i.e. the difference between the bid and ask prices of an asset. For example, a trader placing a market order may notice that his trade is executed at a less favorable price than he expected.
In long trades, the bid price may be higher, while in short trades, the slippage may be due to a drop in the ask price. To avoid this phenomenon in volatile market conditions, traders usually avoid placing market orders unless absolutely necessary.
How to avoid or reduce slippage?
Avoiding or minimizing slippage in trading is an important aspect of successfully executing a trading strategy. Although slippage cannot be completely eliminated, there are several effective strategies traders can use to reduce its impact. Here is a detailed explanation of how to avoid slippage in trading:
1) Use limit orders instead of market orders.
Limit orders allow traders to specify the maximum or minimum price at which they are willing to buy or sell. This can prevent slippage by ensuring that the trade is only executed at the desired price or better. This approach helps to avoid negative slippage, as the order will not be executed if the market price moves unfavorably.
2) Trade in highly liquid markets.
Trading in highly liquid markets can reduce the likelihood of slippage because there are more participants to match orders at the expected price. Major market currency pairs, large-cap stocks, and popular cryptocurrencies such as Bitcoin and Ethereum tend to have high liquidity. By focusing on these highly liquid assets, trades can greatly reduce the likelihood of slippage, as orders are more likely to be filled at or near the expected price.
3) Avoid trading during major news events.
Major news events, such as economic reports, central bank announcements or geopolitical events, can cause sudden spikes in volatility. At such times, prices can move rapidly, increasing the likelihood of slippage. To avoid slippage, traders may choose to refrain from trading during these periods or close existing positions before the news is released.
4) Adopt Stop-Loss Orders
A stop-loss order can help manage risk by automatically closing a position when the price reaches a certain level. It is recommended to set the stop-loss level slightly below a support level (for long positions) or above a resistance level (for short positions). This way, the stop-loss is less likely to be triggered by short-term price fluctuations, reducing the risk of slippage. Although the setting cannot prevent slippage completely, it can limit the potential loss by ensuring that the trade is exited before the price moves too far against the trade.
5) Monitor market conditions and choose the optimal time.
Slippage is more likely to occur in certain market conditions, such as periods of low liquidity or high volatility. Remember to choose peak market hours and avoid trading during periods of low liquidity, such as after hours or during vacations. Slippage is more common during these periods because there are fewer buyers and sellers to match your orders. Being aware of market conditions, including liquidity and volatility, can help traders anticipate periods when slippage is more likely.
Conclusion
Slippage is one of the most important concepts in trading, referring to the difference between the expected and actual execution prices of a trade. To minimize the impact of these slippages, traders can employ several strategies, such as using limit orders instead of market orders, trading in highly liquid markets, avoiding trading during major news events, and carefully setting stop-loss orders.
In addition, monitoring market conditions and choosing optimal trading hours can further reduce the risk of slippage. Although it is impossible to completely eliminate slippage, being aware of its causes and applying these strategies can significantly improve trading results and protect against unexpected losses.
Slippage FAQs
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- Slippage: what is it and how to avoid it?
- What is Slippage?
- What does Slippage produce?
- How to avoid or reduce slippage?
- 1) Use limit orders instead of market orders.
- 2) Trade in highly liquid markets.
- 3) Avoid trading during major news events.
- 4) Adopt Stop-Loss Orders
- 5) Monitor market conditions and choose the optimal time.
- Conclusion
- Slippage FAQs
- Keep Learning 🤓