What Is Slippage?
When a crypto trader executes a trade, they expect to gain a certain price for it. However, what they get in return may sometimes be lower than their expectations due to market risks. The gap or the difference between the expected trade price and the price a trader actually executes a trade is known as slippage.
There are two common situations when crypto slippage may occur. One is when market volatility is high and market orders are being used. The second is when there’s a big-sized order that must be executed even when the volume isn’t sufficient to proceed with the prevalent bid-ask spread.
How does it work?
Suppose, the highest available ask for a Bitcoin is $10,000 at a particular exchange. As a cryptocurrency trader, you want to buy Bitcoin worth $100,000 which would be 10 tokens, not taking into account any fee charged in the process. However, when you execute the order you realise that after spending $100,000, you only got 9.4 Bitcoins. This is because of slippage.
What causes slippage?
As we mentioned above, there are two major conditions that can lead to slippage–when the bid-ask price changes between when the order is placed and fulfilled or when there’s not enough volume to back a large order.
When the markets are volatile, the highest bid and ask change frequently during the time an order is placed and executed. This can lead to both negative as well as positive slippage.
So when the price at which the trade is actually executed is lower than the price that was expected for the market order, your trade would be more favourable as this would be a positive trade. However, it would result in negative slippage if the ultimate execution price is more than the expected price.
In case there’s low liquidity in the market, a lack of enough order book depth can also lead to slippage. The total number of bids and asks on each side of the mid-price are taken into account for calculating an order book depth. Hence if an order book is known to be ‘deeper’, then it would be hard for a large market order to influence the prices.
Slippage in crypto
Slippage in the cryptocurrency market is a far greater concern for traders than in any other financial market. This is because of weaker market depth and the volatile prices that are more recurring in the crypto market. If we look into the causes of why the aforementioned example of slippage occurred, it could be due to a lack of asks. Perhaps there were an insufficient number of asks to fulfill the $100,000 order and hence it became a less favourable trade. What happened was that while the order was placed at $10,000 per Bitcoin, it was fulfilled at various price points that could be $10,100, $10,240, and so on.
How is slippage calculated?
Below are some steps listed to calculate a sample order worth $100,000 which would suggest a possible value for ask slippage. This can be used as an example for various sell orders that have varying values.
Step 1: Scan all the asks in the market by price level till $100k buy order is met. It is a foolproof idea to make the best ask your starting point.
Step 2: Now that you have a fair idea of all asks, calculate the average buy price with the asks required to meet a $100k order. Let’s assume that in an order book you have two asks; €10,000 for 3 Bitcoin and €10,100 for 4 Bitcoin. So your average buy price will come out to be ($30,000 + $40,400)/ 7 = ~ $10,057.
Step 3: Use the formula |Average Buy Price — Best Ask| / Best Ask and calculate the variation percentage between the best ask and the average buy price.
Generally, slippage is expressed as a percentage in decimal form. For instance, an ask slippage of .0006 will depict a .06% change of price between a market order’s expected and executed price. If this number is to be expressed in Basis Point (BIPS), multiply the ask slippage by 10,000. So here the ask slippage will be 6 BIPS.
How to Avoid Slippage when trading crypto?
The cryptocurrency market can be notoriously volatile and thus, there’s no sure shot way of avoiding slippage altogether. But, you can still keep up with the changing token prices and cushion slippage losses. Here’s how:
- Put stop-loss orders in place: Stop-loss orders can minimize your losses as they can give you a guaranteed exit when the market is not in your favor. It is a precautionary measure that will help you avoid slippage.
- Choose a fast broker to execute orders: Trading with a fast-speed broker can be useful to avoid unnecessary slippage-related losses. If your broker is able to trade orders at a good speed, there wouldn’t be enough time for prices to change which could lead to slippage.
- Stay away when the market is too volatile: It helps to be aware of the factors that can affect the market and the prices. Most financial markets including crypto can respond to external factors such as events, announcements, changes in policies, etc. If you note such a possibility, it is best to avoid trading in these situations.
Crypto traders are more likely to face slippage issues in their trades. It occurs when the market price is not the same as the expected price you wished to carry out a transaction on. It may affect your trading plan but that may not always be a negative thing. Slippage can lead to great profit as well as loss. Hence, crypto traders should exercise caution and be mindful of the slippages that may come in the way of their trades. If you’re an amateur trader, it is best to take measures to mitigate losses such as having stop-loss orders in place, learning about the factors that affect the market, and working with a fast broker. Also, observe how experienced traders can turn slippages into opportunities to earn more. They tend to have effective strategies in place for their trades that can help in boosting profit and lowering losses.