Slippage

Often, during high market volatility or low liquidity, the price quoted while placing an order is not the same as the one delivered, and this difference is called slippage. In the sections below, we explore what slippage is in detail and how it can be managed to avoid losses in the market.

Key Takeaways

• In trading, slippage refers to the difference between a trade's expected value while placing an order and the actual value at which the order is delivered to the investor.
• Slippage can be positive (favourable to the investor) or negative (resulting in a loss).
• Causes of slippage include low liquidity and rapid price movements in the market.
• Strategies to minimise slippage include avoiding trading during major economic events, choosing markets with high liquidity or low volatility, and using limit orders.

Slippage refers to the difference between a trade's expected value while placing an order and the actual value at which the order is delivered to the investor. A favourable price difference, one that profits an investor, is called a positive slippage, while one that results in a loss is called a negative slippage.

Markets with low liquidity have fewer investors; hence, the time gap between the order placement and execution is greater, leaving room for price alterations. In highly volatile markets, even before an order is placed, the asset price can change. This is because price movements are swift, and constant shifts are inevitable. Both of these scenarios cause slippage.

Slippage happens when the price difference between buying and selling changes from the moment you want to make a trade to the moment the trade is actually completed. However, what slippage is does not denote any positive or negative movement in the market by itself; any difference in the price, as mentioned above, qualifies as slippage.

It can happen whenever any market-related or external factors are affecting the stock prices at the time. The results can be less, more, or equally favourable for the investor. The final price vs. intended price can be categorised as negative, positive, or no slippage, respectively.

What is slippage can be understood with the help of the below example.

• Let us say you place a trading order at Rs. 1000.
• However, the trade gets executed at Rs. 1100.
• This would result in a 10% negative slippage for the investor.
• A 10% negative slippage means the order was completed at 10% more than the anticipated price.
• Hence, this trade would be a loss-making purchase for the investor.

What slippage is can be best comprehended by exploring the following causes of it in trading:

• High volatility or low liquidity: Markets that are highly volatile in nature have multiple orders going through at the same time, with prices changing constantly. Such market conditions can cause slippage, as the time between order placement and execution may alter the prices. Low liquidity can also cause slippage as there aren't enough traders on both ends of the trade; hence, by the time an ongoing order is bought, the price may have altered already.
• Execution or tech issues: Orders may get delayed due to system errors, tech issues, or inefficiencies during execution. Such instances can cause slippage because the execution price may change during the time gap.
• Economic factors: Market conditions are often affected by ongoing economic and political scenarios in the country. For instance, a sudden change in interest rates can impact the stock market prices. This effect can increase market volatility, causing slippage as a result. 

Now that you know what slippage is, it is also important to understand how it impacts your trades and prices. Slippage is an inevitable part of trading; an investor should always account for slippage in their investment plan.

Here is an analysis of the relationship between slippage and your trading prices:

• Volatility affects slippage: Rapid and significant price movements in volatile markets can cause the actual execution price to deviate from the expected price.
• Reasons for volatility: Economic reports, geopolitical events, and market sentiment shifts can drive rapid price changes, affecting all trades during this period.
• Market fluidity and slippage: Even in less volatile conditions, the ever-changing nature of prices means that slippage is always possible. The market price at the moment of order execution may not exactly match the price the trader sees when placing the order.

Here are some strategies to avoid the pitfalls that come with slippage while trading.

• Major economic events
  Slippage is usually unavoidable in highly volatile markets. Major socio-economic events or announcements can significantly impact market conditions, causing positive or negative slippage depending on the event. Traders can monitor the news and economic calendars to predict fluctuations and avoid placing orders during such periods.
• Low volatility trading
  Chances of slippage can be reduced by trading in markets with high liquidity or low volatility. The latter does not lead to erratic and unpredictable price shifts. Markets with high liquidity are also safe because they have many participants on both ends of trading, thereby increasing the chances of orders going through at the required rates. Both of these markets can help avoid the pitfalls that come with what slippage is.
• Limit orders
  Limit orders are only executed at a specified price. Hence, they can successfully avoid negative slippage for the investor. However, the order might not get executed if the fixed price is not achieved.

Slippage happens when the price at which you buy or sell a stock is different from the price you expected. It usually occurs when the market moves quickly between the time you decide to make a trade and the time it actually happens. To reduce the chances of slippage, first, we must understand what slippage is, try trading when the market is busiest, and focus on trading popular stocks that don't witness major price swings.