What Does Slippage Mean In Trading?

What Does Slippage Mean In Trading?

Traders with even minimal experience on the stock market would have noticed that the prevailing market price and the actual price documented in the order can be different, even for the most liquid of stocks. 

This phenomenon is called ‘slippage’ and is a common occurrence on the stock market. While the markets are generally quite efficient, this efficiency is never perfect, which causes slippages to happen in any type of order. 

In trading, slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed. It is especially common in highly volatile markets, as the price moves at breakneck speeds and can change right before you press the ‘Buy’ button on your trading platform. 

Slippage can vary considerably between stocks. For instance, a S&P 500 stock is less likely to have a high slippage than that of a startup that entered the market via a SPAC merger. 

If you are a beginner trader and would like to know more about what slippage is and how to minimize it, this Investfox guide is for you. 

How Slippage Works In Trading

Slippage can have both positive and negative impacts on a trader's performance. Positive slippage occurs when the trade is executed at a more favorable price than expected, while negative slippage occurs when the trade is executed at a less favorable price.

Slippage depends on a few key factors that make each security different in terms of slippage and overall liquidity, which is why certain stocks and currency pairs are more favorable for day-trading than others. 

Some of the most important factors that contribute to slippage include:

  • Market Volatility: In highly volatile markets, prices can change quickly, leading to slippage as the execution price may differ from the expected price
  • Liquidity: Slippage tends to be more significant in less liquid markets where there are fewer buyers and sellers. In such cases, large orders may cause substantial price movements
  • Order Size: Larger orders may experience more slippage, as they can exhaust the available liquidity at a particular price level
  • Market Orders: Market orders, which are orders to buy or sell at the best available price, are more prone to slippage. This is because the actual execution price can be different from the displayed price when the order is placed
  • News or Events: Sudden news announcements or significant events can lead to rapid price changes, resulting in slippage

How To Minimize Slippage When Trading

There are a few ways to minimize the impact of slippage on your trades. The first, and the most obvious method, is to focus your attention on highly liquid instruments, which includes large-cap stocks and major currency pairs, which tend to be less volatile and enjoy a stable stream of liquidity on their respective markets. 

Another way of reducing slippage is to place limit orders on specific prices, which makes sure that the order is filled at the limit price only. 

For example, if the price of Amazon stock (AMZN) is hovering between $146.05 and $146.30 over a space of a few minutes. Placing a limit buy order at $146.20 can help you reduce slippage and only buy at that specific price, at which point your slippage may be a couple of cents. Of course, this also depends on the amount of shares you are buying. If you choose to buy a large volume of shares, this will also affect the going market price of the stock. 

amzn stock.png

Key Takeaways From What Does Slippage Mean In Trading

  • Slippage is a trading term used to describe the difference between the market price of an instrument and the actual price at which a trade order is executed
  • The degree of slippage depends on several factors, such as liquidity, volatility, and the order type used by the trader
  • To minimize the effects of slippage in stock and forex trading, traders can resort to trading instruments with high liquidity and do so using limit orders set at specific price points 

FAQ On Slippage In Trading

Is a high slippage bad in trading?

High slippage can be detrimental in trading as it may lead to larger-than-expected losses or reduced profits. Minimizing slippage is crucial for achieving more accurate trade executions and better alignment with a trader's intended entry or exit points.

How to reduce slippage in forex trading?

To reduce slippage in forex trading, use limit orders instead of market orders, especially during volatile periods. Monitor market liquidity, trade during high-liquidity periods, and consider using advanced order types and risk management strategies.

Can limit orders stop slippage?

Yes, limit orders can help minimize slippage by allowing traders to specify the maximum price at which they are willing to buy or the minimum price at which they are willing to sell, reducing the impact of unexpected price changes during execution.