What is Slippage? How to limit Slippage when trading?

When participating in market trading, you’ve undoubtedly encountered Slippage several times. Many traders have unfairly suffered losses due to Slippage. So, what exactly is Slippage? Why does it happen? How can we avoid Slippage? Let’s find out in the content of the article below.

What is Slippage?

Slippage, also known as price slippage, occurs when the actual execution price differs from the price you set.
If you’re not familiar with what Slippage is, let me give you an example:

– Suppose you plan to BUY EUR/USD at 1.12400.

– But perhaps due to high volatility, your order is executed at 1.12550. (higher than the price you intended to set)

At this point in the Forex market, the difference amounts to about 15 pips. This is negative Slippage – meaning you suffer, having to BUY at a slightly higher exchange rate.

You can see, this Slippage is a negative price slippage.

But don’t worry…

Sometimes you can also receive positive Slippage. For example:

– Suppose you plan to BUY EUR/USD at 1.12400.

– But instead, your order is executed at 1.12350 USD.

You gained 5 pips here – so it’s positive Slippage – you buy at a slightly cheaper rate.

Why does Slippage (price slippage) occur?

Slippage (price slippage) often occurs when you use market orders to execute trades.
You might wonder why, although you set a Stop Loss at a certain price, it still gets executed at, say, XXX – 1.

The reason is that the Stop Loss price is only a conditional price. When that price is reached, the system activates your Stop Loss order at the market price. That’s why sometimes your Stop Loss order experiences significant price slippage.

So, what causes Slippage? In my opinion, there are three main reasons:

First: Strong market volatility

When the market is highly volatile, whether negatively or positively, it’s when many investors rush to place orders.
Example: You intend to sell ETH at $2,000, but due to low gas fees, someone else sells before you ⇒ Causing the price of ETH to drop.

So, by the time your order is executed, the price might only be $1,950 or $1,900.

Or in the Forex market, during times of hot news releases such as CPI, interest rates, etc., many investors experience FUD/FOMO, causing significant market volatility, and Slippage is likely to occur.

Second: Market lacks liquidity

Slippage also occurs more frequently when the market is less liquid with lower trading volumes.
Imagine trading on a cryptocurrency exchange where the BUY and SELL walls only have a few ETH. But someone wants to quickly sell 1,000 ETH at once, then surely it will cause a significant drop in price without braking, resulting in slippage.

Or on a DEX, liquidity on AMM depends on the Pools. If liquidity in those Pools is too low and you want to trade in large amounts, liquidity will drastically decrease.

For example, the image below shows the BUSD – ONT pair. This investor wants to swap 2,000 BUSD for ONT. On a CEX, $2,000 is not a big amount, but on a Dex (specifically Pancakeswap), the Pools containing ONT have almost no liquidity, leading to transactions sometimes experiencing up to 64% slippage, just one click away from dividing your account by four.

Third: Front Running Bots

Front-running bots exploit the knowledge of a future trade that will impact prices and place orders right before that trade to profit for themselves.

Front Running impacts prices and creates slippage in the following way:

1. Front-running bots detect a transaction that can be front-run (significant enough slippage, high enough impact on price to make a profit).
2. They insert a buy order with a reasonable size and volume (since the buy order itself will also affect the price) just before the user’s order.
3. They unload immediately after the user’s order is executed. The bots’ profit lies in the slippage caused by the user, creating an opportunity to buy low and sell high.

How to Limit Slippage in Trading?

Slippage, if it works in the trader’s favor, can lead to significant profits; conversely, it can also lead to account burnout. Thousands of traders worldwide have encountered such situations in various markets: securities, coins, forex…
You can’t completely avoid slippage because you can never be sure when a large order will be placed in the market, nor can you predict global political events. However, you can minimize the risk of slippage in the following ways:

• Use Limit orders instead of Market orders. However, Limit orders may sometimes prevent you from buying/selling in time during volatile market movements.

• Limit trading during times of high volatility: times when market-affecting news is about to be released, especially in Forex. If you lack experience – stay away from these times.

• Trade only with coins/currency pairs that have high liquidity. For example, in Forex, prefer trading when the New York or London markets are open, or trade major currency pairs like EUR/USD, GBP/USD… When liquidity is high, slippage occurs less frequently.

• Keeping an eye on the economic calendar is never redundant for a trader. You may not be interested in the news, but you need to know when it will be released, and ideally, what the news is about and how it might impact the market. You can view the news release schedule on Forexfactory.com or investing.com.

The above are the details about what Slippage is. Hopefully, this article has helped you understand Slippage (price slippage) so that you can best avoid this situation. If you have any questions, please leave a comment below for me to answer. Thank you for reading the article and wishing you successful investing.