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Slippage is the difference between the price at which a trader expects to execute a trade and the actual price at which the trade is executed.
It usually occurs when market prices move quickly or when there is not enough liquidity at the desired price.
Learning why it occurs will assist traders with managing their execution risk. Keep reading for a deep dive.
Key Takeaways
- Slippage is the discrepancy between the expected price of a trade and the price at which the trade is actually executed.
- It might be beneficial or negative.
- The usual suspects include high volatility and poor liquidity.
- Any order can experience slippage, but it is more likely with market orders.
- Large orders may experience slippage if there isn’t sufficient volume at the price.
- Limit orders give control over the execution price, but they may not be filled.
- Slippage can affect the entry price, exit price, and overall trading profits.
What Does Slippage Mean in Trading?
Slippage occurs when your order is filled at a price lower than you initially requested.
For example, suppose you wish to buy a stock at ₹100, and you submit a market order. When the order reaches the exchange, the price available has changed to ₹101. That ₹1 difference is slippage.
This is because prices can change between when an order is placed and when it is executed in highly fluid or fast-moving markets. This is what slippage is.
How Does Slippage Work?
The price seen when a trader submits an order may not be accessible when the order reaches the exchange.
For example, suppose a trader makes a market order to buy 1000 shares at an estimated price of ₹200.
Due to limited liquidity:
- 500 shares at ₹200
- 300 shares at ₹201
- 200 shares at ₹202
So, the order could be executed at an average price above ₹200. The gap between the expected and average execution price is called slippage.
Kinds of Slippage
Negative Slippage
Negative slippage occurs when a deal is filled at a less favourable price.
It is important to ensure you have the necessary equipment and that it is in good working order.
You want to buy at ₹100, but the order is executed at ₹103.
You place an order expecting to sell at ₹100; it gets executed at ₹97.
Negative slippage can either increase trading costs or lower profits.
Positive Slippage
Positive slippage occurs when a trade is executed at a better price than expected.
For instance:
- You expect to buy at ₹100, but the order executes at ₹98.
- You expect to sell at ₹100, but the order executes at ₹102.
While traders tend to view slippage as negative, it can also be positive.
What Causes Slippage?
There are several reasons that contribute to the increased likelihood of slippage.
High Market Volatility
Prices can vary quickly in uncertain market conditions. The advertised price is not guaranteed by the time your purchase is finalized.
This happens regularly during:
- Key economic releases
- Company results
- Unforeseen news
- Market opening and closing times
- Sudden market moves
Poor Liquidity
There may not be enough buyers or sellers at the price you want in a sparsely traded security. The order may then be filled at the next available price.
Securities with high liquidity are likely to have more market participants and deeper order books, which can help prevent slippage.
Big Order Size
A big order can take the available quantity at the greatest price. The remaining quantity may then be filled at gradually different costs. This is especially true for equities or derivatives with less trading volume.
Failures of the Market
Prices can often surge from one level to another with no trade at all in between. This might occur after huge news, overnight developments, or other abrupt events.
For example, a stop-loss order may be filled far from where the stop was triggered if the market moves quickly.
Type of Order
Market orders prioritize execution, so they are usually filled at the best possible price when they reach the market. In fast-moving settings, this can increase the risk of slippage.
Market Orders and Slippage
A market order is all about getting the trade filled fast. An exact execution price is not guaranteed.
Let’s say a stock is trading at roughly ₹500. A trader enters a market buy order, but the available selling price changes before the transaction is processed. The merchant may get a price of ₹502.
This doesn't necessarily mean that the trading platform made an error. Maybe the market got ahead of the order.
Slippage & Limit Orders
A limit order lets a trader designate the price at which they want to buy or sell.
If you place a buy limit order at ₹100, the order will not be executed if the price is above ₹100. A sell limit order above ₹100 will not execute below ₹100.
This can help to control negative slippage. The drawback is that the order may not be completed if the market does not reach the required price or if there is not enough quantity available.
Example of Slippage
Suppose a trader wishes to buy an option contract that is currently trading at ₹50.
The trader enters a market order, but prices are moving swiftly.
The average fill price by the time the order is executed is ₹54.
Price: ₹50
Actual price: ₹54
Slippage per unit: ₹4
If the lot size is 100 units, the total difference due to slippage will be:
₹4 × 100 = ₹400
Thus, the trade begins with an extra execution cost of ₹400 compared to the projected entry price.
Slippage Formulas
- Slippage per Unit: Slippage per Unit = |Expected Execution Price − Actual Fill Price|
- Total Slippage Cost: Total Slippage Cost = Slippage per Unit × Traded Quantity (or Lot Size)
Slippage vs Bid-Ask Spread
Slippage and the bid-ask spread impact trading expenses but are distinct.
| Feature | Slippage | Bid-Ask Spread |
| Definition | The discrepancy between the expected execution price and the actual fill price. | The absolute difference between the highest price a buyer is willing to pay (Bid) and the lowest price a seller is willing to accept (Ask). |
| Visibility | Known and calculated after the trade has been executed. | Fully transparent and visible before placing the trade in the order book. |
| Primary Driver | Rapid market volatility, low liquidity depth, or large order sizes sweeping the order book. | Market structure, overall trading volume, and underlying liquidity of the asset. |
| Nature | Variable and unpredictable based on order routing speed and market pace. | Dynamic but continuously quoted in real time by market participants. |
Low liquidity leads to bigger spreads and more slippage.
How to Minimise Slippage
Slippage can't always be avoided, but traders can take steps to limit it.
- Limit Orders: While there is no guarantee that your order will be filled, it allows the trader more control over their order fill price.
- Trade Liquid Securities: Stocks/contracts that are actively traded with more depth to the order book can result in a tighter execution and less slippage.
- Steer Clear of High Volatility Periods: Major news developments and abrupt market moves can generate rapid price changes. If you’re not trading volatility in particular, you might not want to be dropping large market orders at such times.
- Break Down Big Orders: This is helpful to limit the impact of eating available liquidity at one price level by splitting a large transaction into smaller orders.
- Check Out the Order Book: Traders can see the bid and ask quantities available before they place a trade. Thin order books may be more vulnerable to slippage.
What is Slippage for Traders?
Slippage can affect both profits and losses.
For a trader who uses tight targets and stop-losses, even a minor variance in execution price can make a big difference in the risk/reward ratio. This is especially true for intraday traders and scalpers who trade many times.
For longer-term investors, tiny execution discrepancies may be less important, although liquidity and execution quality may still matter as it pertains to major transactions.
Positive slippage can lead to a better outcome, whereas negative slippage might result in higher costs or a loss bigger than anticipated.
Benefits of Knowing Slippage
- Helps traders comprehend the difference between quoted and execution prices.
- Incentive to make better order choices.
- Emphasises the necessity of liquidity.
- Helps in planning realistic entry and departure points.
- Can enhance risk and position size management.
Limitations and Risks
Slippage is always present, and fast-moving markets can leave even limit orders unexecuted.
Market orders prioritise fill speed over price certainty, whereas limit orders lock in the price but risk non-execution.
Volatile or illiquid assets experience greater slippage, which can significantly affect realised trading returns.
Conclusion
Slippage in trading is the difference between a trader's expected price and the execution price. This slippage can be negative or positive. Slippage depends on order type, volatility, liquidity, and order size.
This phenomenon is something we cannot help with in any way. All that a trader can do is minimise this slippage. Use the order types you need, trade volatile and liquid instruments, and be cautious when placing very large orders.
