What is Slippage?

Slippage is the difference between the price of a trader's intended trade and the price when the actual trade executes, which can significantly impact profit and losses.

For example, imagine you are out shopping for sneakers and find the perfect pair for $100. By the time you reach the cash register to check out, the price has suddenly jumped to $115. The extra $15 is considered slippage.

While slippage can happen at any time, it occurs the most during volatile markets or when orders exceed the available liquidity on the platform.

Due to the volatile nature of the crypto markets and the varying liquidity of different cryptocurrencies, understanding this concept is essential for any trader in this space.

Types of Slippage

Slippage can occur in different forms, with each having their own implication for traders.

Positive Slippage

Positive slippage happens when a trade executes at a better price than originally anticipated.

For buy orders, this is when the asset is purchased for a lower price than what was expected, saving the trader money. For a sell order, positive slippage occurs when the asset is sold at a higher price than expected, netting the trader a greater profit.

This outcome occurs in fast-moving markets when the asset price decreases quickly, or when trading on platforms with high liquidity and efficient order execution. While the price difference can seem small, positive slippage can impact profitability over time for high-frequency traders.

Negative Slippage

Negative slippage is more common and happens when the market price changes unfavorably before a trader’s order is filled, resulting in a less profitable trade.

For buy orders, this translates to paying a higher price than anticipated, while for sell orders, it means receiving a lower price than what traders sold the asset for.

Several factors contribute to negative slippage, including:

1. High Volatility: rapidly fluctuating prices, which happens often in the crypto space, often make it difficult for orders to be filled at the desired price.
2. Low Liquidity: When there are few buyers or sellers for a particular asset, even small orders can significantly impact the price. This lack of liquidity creates wider gaps between buy and sell orders, leaving traders vulnerable to slippage.

For traders, negative slippage impacts potential profits and can even lead to unexpected losses. It's a crucial factor to consider, particularly in fast-moving or less liquid markets.

Causes of Slippage in Crypto Markets

The two main causes of slippage in the crypto markets are high volatility and low liquidity, as mentioned above. However, there are several other factors traders must consider:

• High Trading Volume – A sudden influx of buy or sell orders (due to a news event for example) can rapidly shift market prices. During these high-volume periods, even small orders can experience slippage as they struggle to get filled at their desired price levels.
• Order Book Depth – A thin order book (essentially a list of buy and sell orders) with few orders at different price levels can cause slippage, especially for larger trades.  When there aren't enough orders available to fill an entire order at the desired price, it will be partially filled at progressively worse prices.
• Time Delay – In fast-moving crypto markets, prices can change significantly within seconds, meaning an order might be filled at a different price than initially intended.

Understanding these additional factors will better equip traders to anticipate and manage slippage in their crypto trades.

How to Minimize Slippage in Crypto Trading

While slippage is an inevitable part of trading, there are several strategies traders can employ to minimize its impact and protect their profits. These include:

• Limit Orders – Traders can set the maximum price they’re willing to pay (for a buy order) or the minimum price they’ll accept (for a sell order).
• Market Orders – Market orders execute immediately at the current market price. While convenient, this speed makes market orders the most vulnerable to slippage, especially in volatile conditions.
• Choosing the Most Liquid Markets – Traders should prioritize exchanges with high trading volume and liquidity. A deeper order book means orders are most likely to be filled at the desired price.
• Trading Smaller Amounts – Splitting large orders into smaller ones can minimize slippage and ensure better trade execution.
• Slippage Tolerance – Some platforms offer a 'slippage tolerance' setting, allowing traders to control the maximum price difference they'll accept. Of note, if set too low, the order might never get filled.

Conclusion

Slippage is an important concept for every crypto trader to understand.

Whether it's positive or negative slippage, grasping their root causes – from volatility and liquidity to order book depth and time delays – will allow traders to make informed decisions to minimize its impact.

While some slippage is unavoidable, with knowledge and the right strategies, traders can mitigate its effects and trade with greater confidence in the crypto markets.