What is Slippage
Slippage is a term commonly used in the financial markets, including cryptocurrencies, to describe the difference between the expected price of a trade and the actual price at which the trade is executed. This phenomenon typically occurs during periods of high volatility, low liquidity, or when large orders are placed. Slippage can lead to traders receiving less favorable prices than anticipated, impacting their overall trading strategy and profitability.
The concept of slippage originated in traditional finance, where it was particularly relevant for large institutional traders. However, with the rise of cryptocurrency trading, slippage has become a significant concern due to the often volatile nature of digital asset markets. Traders need to understand slippage to effectively manage their trades and employ strategies that mitigate its effects.
What are the types of Slippage?
There are two primary types of slippage: positive slippage and negative slippage.
Positive Slippage: This occurs when a trader receives a better price than expected, usually due to rapid price movements in their favor. For example, if a trader places a buy order at $100 and the order is executed at $98, the trader experiences positive slippage of $2.
Negative Slippage: This is the more common scenario, where the execution price is worse than expected. For instance, if a trader places a sell order at $50 and the order is filled at $48, the slippage is $2 in the trader's disadvantage.
How does Slippage work?
Slippage occurs primarily due to market dynamics, such as supply and demand fluctuations. When a trader places an order, especially a market order, it is executed at the best available price at that moment. However, if the market price changes rapidly, the order may be filled at a different price, leading to slippage.
For example, consider a scenario where a trader wants to sell 100 BTC at a market price of $30,000. If there aren't enough buyers at that price, the order might be partially filled at $30,000 and the remainder at lower prices as the order book adjusts, resulting in a worse average execution price. This effect can be exacerbated in thinly traded markets where larger orders can significantly impact the price.
Traders can use limit orders to minimize slippage, as these orders specify the maximum or minimum price at which they are willing to buy or sell. However, using limit orders may result in the order not being filled at all if the market does not reach the specified price.
Where is Slippage used?
Example 1: A trader executing a $5 million market order for Bitcoin experiences negative slippage, resulting in a filled price of $29,800 instead of the expected $30,000, leading to a loss of $200,000 on the trade.
Example 2: During a volatile trading session, a trader attempts to buy 50 ETH at $1,800, but slippage causes the order to execute at $1,810, resulting in a total cost increase of $500.
Example 3: An automated trading bot places a large sell order in a low-liquidity market, causing slippage that results in an average execution price of $0.10 per token, whereas the initial expected price was $0.12, leading to a $200 loss on a $1,000 investment.
