What Does Slippage Mean and How Can You Minimize It?

Slippage is a common occurrence in financial markets where the actual price at which a trade is executed differs from the expected price at the moment the order is placed. This difference can arise due to the rapid movement of prices between the time a trader initiates an order and when that order is actually filled on the exchange. This phenomenon is a normal part of trading across various asset classes, including stocks, foreign exchange, and commodities.

Understanding Slippage

Slippage occurs when a market order is placed, but the market price changes before the order can be fully executed. The “expected price” is the price displayed to the trader at the time they decide to buy or sell an asset. The “executed price” is the actual price at which the transaction is completed. The difference between these two prices constitutes slippage, which can be a small fraction of a cent or several pips, depending on the asset and market conditions.

This price difference can manifest in two ways: negative slippage or positive slippage. Negative slippage happens when a buy order is filled at a higher price than expected, or a sell order is filled at a lower price than expected. For example, if a trader expects to buy shares at $50.00 but the order fills at $50.05, that $0.05 difference per share is negative slippage. This outcome can reduce potential profits or increase losses on a trade.

Conversely, positive slippage occurs when a buy order is filled at a lower price than expected, or a sell order is filled at a higher price than expected. If a trader anticipates selling an asset at $100.00 but the order executes at $100.10, the $0.10 difference per unit represents positive slippage. This scenario is beneficial to the trader, as it results in a more favorable execution price than initially anticipated.

Factors Influencing Slippage

Market volatility significantly contributes to the occurrence of slippage. When prices are moving rapidly, the time lag between placing an order and its execution can result in the market price shifting away from the desired entry or exit point. High volatility often means larger price swings, increasing the probability and magnitude of slippage.

Liquidity, the ease with which an asset can be bought or sold without affecting its price, also influences slippage. In low liquidity markets, there may not be enough buyers or sellers at a specific price to immediately fill a large order. This forces the order to be filled at progressively worse prices, leading to greater slippage. Thinly traded assets are more susceptible to this than highly liquid instruments.

The size of an order is another influencing factor. A very large market order can “eat through” available liquidity at the best current prices. This process, known as price impact, can result in significant slippage, especially in markets where order books are not deep enough to absorb the entire order at a single price point. Smaller orders generally experience less price impact and less slippage.

Sudden market news and events can drastically increase the likelihood of slippage. Unexpected economic reports, geopolitical developments, or company announcements can trigger immediate and sharp price movements. During these times, bid-ask spreads often widen considerably, and market participants react quickly, making it difficult for orders to be filled at pre-event prices.

Minimizing Slippage

One of the most effective strategies for minimizing slippage involves the careful selection of order types. Market orders instruct a broker to execute a trade immediately at the best available price, which makes them highly susceptible to slippage, especially in volatile or illiquid markets. There is no guarantee regarding the execution price, only that the order will be filled. This can lead to unexpected costs or reduced returns if the price moves unfavorably.

Conversely, limit orders provide a degree of control over the execution price. A limit order specifies the maximum price a trader is willing to pay for a buy order or the minimum price they are willing to accept for a sell order. For example, a buy limit order at $50.00 will only execute at $50.00 or lower, preventing negative slippage beyond that price. While a limit order guarantees a specific price or better, the trade-off is that the order may not be filled at all if the market price does not reach the specified limit.

Traders can also reduce potential slippage by focusing on trading during periods of high market liquidity. Highly liquid markets, such as major currency pairs during peak trading hours or large-cap stocks, typically have deeper order books and tighter bid-ask spreads. This abundance of buyers and sellers at various price levels makes it more likely that an order will be filled close to the expected price. Avoiding trading during off-peak hours or when significant news events are anticipated can also help mitigate slippage risk.