Trading is a complex phenomenon. It may take years, if at all, to get really good at making the right trades. But even experts go through those days when what they expect and what they actually gain or lose are completely different. This is because the markets are constantly fluctuating space, with many factors beyond human control influencing the prices of assets. This phenomenon is reflected excellently in the concept of slippage. Wondering what that is? Well, this blog will take you through what slippage is and tell you all that you need to know about this commonly occurring concept in the financial markets.
What is slippage?
So, let’s begin at the basics and cover the slippage meaning. In technical terms, slippage refers to the difference between the expected price at which a trade is placed and the actual price at which the trade occurs. In simpler terms, it occurs when the order that you placed on the exchange is executed at a price that’s different from the price that you requested.
Now, say you placed a request on the exchange to purchase 10 stocks of a company at Rs. 104 each. Due to the concept of slippage, the order was instead executed at Rs. 102 per share. This is slippage in action. And sometimes, such as in the case discussed above, it can be in your favor, since you get to purchase the asset at lower prices. But at other times, slippage can also work against you and bring unfavorable outcomes.
Slippage commonly occurs in the stock markets and in the forex markets. But what is the reason behind the difference between the requested price and the executed price. Come, let’s find out.
Why does slippage occur?
You know the slippage meaning now. But why does it occur? At first glance, it may appear that slippage is just an error. But it certainly isn’t so. Slippage happens in markets that are extremely volatile. This means that the prices of the assets being traded are fluctuating so frequently that it’s not possible to request a trade at a specific price and have it executed at that point. Price changes may happen so quickly in volatile markets that in the time that it takes for you to place your order, the price may have gone up or down by a few points. This leads to the order actually getting executed at a different price that what you expected.
Slippage may also occur in times of low liquidity in the market. This means that there are very few market participants. So, finding a buyer who is willing to purchase the stocks or assets you’re selling at the price you wish to sell them can be difficult. Similarly, finding a seller who is willing to sell the asset you wish to buy at the bid price you’re seeking can also be tough.
Slippage can be positive or negative, as we briefly discussed earlier. Let’s take up some slippage examples to see how it comes into play practically.
Say you wish to purchase the USD/INR pair at the current market rate, which we’ll assume is Rs. 70.20. You fill in the order and then find that the best available bid price is Rs. 70.10. Your order is then executed at this lower price, making it a positive slippage because you get to purchase the asset for much less than expected.
Conversely, say you wish to purchase the USD/INR pair at the current market rate, which we’ll again assume is Rs. 70.20. You fill in the order and then find that the best available bid price is Rs. 70.40. Your order is then executed at this higher price, making it a negative slippage because you get to purchase the asset for much higher than expected.
While slippage can occur at any point in time, it’s most common in volatile markets or less liquid markets. So, if you wish to avoid the effects of slippage, it is best to take certain precautions. For starters, steer clear of extremely volatile markets. Also, try and refrain from trading when there’s a major economic event happening, since those events could quickly impact asset prices. Another way to minimize slippage in your transactions is to make use of limit orders instead of market orders, so your order will only be filled at the requested price or at a better one. This way, you can remove the chances of negative slippage affecting your trades.