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Slippage is the difference between the price you expect to receive when placing an order to buy or sell cryptocurrency and the price you actually receive when the order is executed. Since most cryptocurrencies are highly volatile, slippage is a significant issue. Get a better understanding of slippage and learn ways to minimize it when trading cryptocurrencies here.
Key Takeaways
- Slippage is the difference between the price at which an order to buy or sell was entered and the price at which the order is executed.
- Cryptocurrencies can be subject to significant slippage due to the extreme volatility in the market.
- Slippage can be calculated as a dollar amount or as a percentage.
- Limit orders can help you reduce slippage by allowing you to specify a particular price. The order is executed at that price or better, but it might not be executed at all.
- Some crypto exchanges have safeguards in place to help traders minimize slippage.
Slippage is the difference between the price a trader enters on their order and the price at which the order finally executes. It occurs in all types of investments, including stocks, bonds, currencies and other assets. However, it is especially prevalent in cryptocurrency because of the extreme volatility sweeping the market on a daily basis.
What Causes Slippage?
Slippage becomes a problem whenever there is volatility in the market, which is why the crypto market, in particular, is so prone to it. The problem occurs whenever the spread between the bid and the ask changes between the time the order is placed and the time the crypto exchange executes it.
Aside from volatility, another principal cause of slippage is the amount of liquidity in the market.
Liquidity represents how quickly tokens of a particular cryptocurrency are changing hands. The more liquidity there is in the market, the more often tokens of a selected digital currency are trading.
When more tokens are trading frequently, it becomes much easier to buy or sell that cryptocurrency because there is a steady supply of traders wanting to buy or sell. However, if not many traders are exchanging a particular cryptocurrency, it will be difficult to buy or sell its tokens.
Slippage increases when liquidity in a cryptocurrency is low because it becomes much more difficult to buy or sell it. You may end up paying a lot more than you want or receiving a lot less than you want if liquidity is low.
How Is Slippage Calculated?
Slippage is often expressed as a percentage, although it is first calculated as a dollar amount. The higher the percentage, the greater the spread between the bid and the ask prices. Slippage can be both positive or negative based on whether the impact to the trader is favorable or unfavorable. Positive slippage benefits the trader, while negative slippage indicates price movement that is detrimental to the trader.
To calculate slippage, you take the expected entry price and subtract the actual execution price, which gives you the slippage in dollars and cents. If the order is executed at multiple prices in multiple transactions, then you can get the slippage by subtracting the average execution price from the expected entry price.
To calculate slippage as a percentage, which is the form used by most trading platforms, you divide the numerical slippage by the difference between the expected entry price and the worst possible execution price and then multiply by 100.
For example, let’s say you expect to buy one bitcoin at $49,000. However, your trade ends up executing at $49,500 because the price changed between when you placed the order and when it was executed.
The worst-case scenario was $50,000.
The slippage is $500, which is the difference between $49,000 and $49,500. The slippage in the worst-case scenario would be $1,000, which is the difference between the worst-case scenario price and the expected entry price.
The slippage percentage is $500 divided by $1,000, which is 0.5. Then you multiply that number by 100 to get the percentage, which is 50%.
Market Versus Limit Orders
The easiest way to reduce slippage is to place limit orders instead of market orders. A market order is the most basic type of order to buy or sell an asset such as a cryptocurrency. This type of order is executed as soon as possible at the best available market price.
It doesn’t guarantee the price at which the order is filled, but it does almost guarantee that the order will indeed be executed as long as a trader is placing the opposite order for the cryptocurrency. When you place a market order for cryptocurrency, it is very unlikely that you will get the price you expect because of how rapidly prices in the crypto market change. However, you can rest assured that you will be able to buy or sell your tokens.
A limit order allows you to set a minimum or maximum price at which the order will be executed. If you’re selling cryptocurrency with a limit order, the order will only be executed at or above the price you specify. On the other hand, if you’re buying cryptocurrency with a limit order, the order will only be executed at or below the price you specify.
How To Reduce Slippage In Crypto Trading
To reduce slippage, you can use a limit order because it allows you to control how much slippage is allowed. However, the order is not guaranteed to be executed. If the actual price of the cryptocurrency you’re trading never reaches the price you specify in the order, it will not be executed, and you will not buy or sell your cryptocurrency. This could mean lost opportunities in some cases, which is why it’s not always wise to use a limit order in every situation.
Some cryptocurrency exchanges take other steps to help traders minimize slippage. For example, COINBASE shows a slippage and average price estimate on every market order to help traders avoid accidentally placing an order at an unattractive price.
Other exchanges show a slippage warning when the market conditions are such that an order can be subject to significant slippage if placed at that time. Different crypto exchanges use different cut-off points, usually around 2% or 3%.