Slippage in Finance: Definition, Causes, and Examples

An in-depth exploration of slippage in financial trading, including its definition, causes, types, examples, and impact on traders and investors.

Definition of Slippage

Slippage refers to the discrepancy between the expected price of a trade and the price at which the trade is actually executed. This phenomenon is prevalent in financial markets and is influenced by various factors such as market volatility, order size, and liquidity.

Causes of Slippage

Market Volatility

High volatility makes it difficult for trades to execute at expected prices. Rapid price changes mean a trade initiated at one price can be executed at another.

Order Size

Larger orders may influence the market price or may not be filled at a single price point, leading to slippage as the trade is executed at multiple price levels.

Liquidity

Low liquidity conditions make it harder to find a willing counterparty at the expected price, resulting in slippage as trades are executed at available prices.

Types of Slippage

Positive Slippage

Occurs when a trade is executed at a better price than expected. This is beneficial to traders as they gain more than anticipated.

Negative Slippage

Occurs when a trade is executed at a worse price than expected. This results in a loss for the trader, making it crucial to manage and mitigate.

Examples of Slippage

• Stock Market Example: If an investor places a market order to buy 1000 shares at $50 but the order is executed at $50.10, the slippage is $0.10 per share.
• Forex Market Example: In the forex market, a trader might set a limit order to buy at 1.1500 EUR/USD, but due to high volatility, the execution occurs at 1.1510, resulting in negative slippage.

Impact of Slippage

Slippage can significantly affect the performance and profitability of trading strategies. Understanding its impact and how to mitigate it is essential for traders. For example, using limit orders instead of market orders can help control the execution price more effectively.

Special Considerations

Mitigating Slippage

• Use Limit Orders: Set a specific maximum or minimum price at which you’re willing to execute the trade.
• Trade During High Liquidity Periods: Execute trades during peak market hours to enhance the chances of matching expected prices.
• Monitor Market Conditions: Stay informed about upcoming events or news that may cause high volatility and adjust strategies accordingly.

Related Terms

• Bid-Ask Spread: The difference between the highest price a buyer is willing to pay for an asset and the lowest price a seller is willing to accept.
• Market Order: An order to buy or sell a security immediately at the current market price.
• Limit Order: An order to buy or sell a security at a specific price or better.

FAQs

Can slippage be entirely avoided?

While it’s challenging to eliminate slippage entirely, especially in volatile markets, strategies like using limit orders and trading during high liquidity periods can minimize its impact.

Does slippage occur in all financial markets?

Yes, slippage can occur in any financial market, including stocks, forex, commodities, and cryptocurrencies.

How do brokers handle slippage?

Different brokers may have different policies for handling slippage, but generally, they will execute trades at the best available price, which might not always match the trader’s expected price.

Summary

Slippage is an important concept in financial trading, representing the divergence between the expected price of a trade and the actual execution price. Understanding its causes, types, and strategies to mitigate it can significantly impact trading performance and profitability.

References

• Investopedia. “Slippage Definition.” Investopedia.com.
• Babypips. “What Is Slippage?” Babypips.com.

By being aware of slippage and taking appropriate measures, traders and investors can improve their trade execution and overall success in the financial markets.