Hello friends, welcome to today’s podcast by Angel Broking.
Today we are discussing the concept of slippage in trading.
To understand it better, let’s take the example of Vihan.
Vihan is a newbie to the world of trading. Like many young people, he made a Demat account during the quarantine and has been investing in stocks. Yesterday, Vihan placed an order on the exchange for a share that would have cost him 2000 rupees. Now I say, ”would have cost him” because when the order actually got executed this morning, Vihan had to pay 2300 for it.
Confusing, isn’t it? How is that even possible?
Well, on seeing the discrepancy in prices, Vihan first thought it was an error. Then he figured that a slippage must have occurred.
The term Slippage refers to the difference between the expected price at which a trade is placed and the actual price at which the trade gets executed. In Vihan’s case, the expected price was 2000 and his order got executed at a different price.
Our man Vihan got unlucky and the slippage was negative. That is, the trade got executed at a higher price than expected, making Vihan pay more. But a lot of the time, a positive slippage can also occur!
Say you wish to trade in the USD/INR pair at the current market rate- let’s assume it is Rs. 73. You fill in the order and then find that the best available bid price is Rs. 70.5. 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.
But why does any slippage ever occur in the first place?
Slippage is actually a fairly common occurrence in stock markets and forex markets, and can happen for many reasons.
Slippage often occurs in markets that are extremely volatile. This means that the prices of the assets being traded are fluctuating very frequently. So it’s almost impossible 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.
Slippage can also occur in times of low liquidity in the market. When there are only few participants in the market, finding a buyer who is willing to purchase the stocks or assets you’re selling at the price you want to sell them, can be difficult. Similarly, finding a seller who is willing to sell the asset you want to buy, at the bid price you’re seeking can also be tough. When a large order gets executed with not enough sellers at the ask price, then the price slips.
Some times, when you place a market order towards the end of the trading day, the order gets executed in the morning at a different price altogether. This is because all market orders are executed in a queue along with other market orders. By the time yours gets a chance to be executed, the price action gets affected also by the buyers and sellers in the queue before you. Hence, it is always advised to not place an order after the markets have closed, as there is a strong possibility that the opening price will be different from the requested price in the previous evening.
This is exactly what happened with Vihaan. The price of the share slipped up by 300 rupees by the time his order got executed.
Vihaan could have avoided this. Firstly of course, by not placing an order after markets had closed. But what about other scenarios? For anyone who wants to avoid such slippages, there are some precautions to keep in mind.
For starters, steer clear of extremely volatile markets. When prices are moving up and down too fast, it is impossible to pinpoint the actual price you would have to pay for the asset. Vihan ignored the volatility in price action of the asset he bought. Which is why the slippage that did occur was also a significant amount.
Also, when there’s a major economic event happening, or a significant cultural trend is emerging, it could quickly impact asset prices. Which is why you should try and refrain from trading during those events before closely monitoring the markets.
An easy and convenient way to minimize slippage in your usual transactions is to make use of limit orders instead of market orders. With limit orders, your order will only be fulfilled at the requested price or at a better one. This way, you can eliminate the chances of negative slippage impacting your trade.
For example, if Vihan had placed a limit order of Rupees 2000, his trade would have executed only when the price reached Rupees 2000 or lesser. This is not recommended when you really, really want to buy a particular asset. As limit orders have a price condition, it is possible that your order will never get executed simply because the ask price will not match your limit. In simple terms, there is no guarantee that you will purchase the asset.
Trading, while being convenient, can also get complicated if you do not know what to look out for. So to avoid any slippage, you need to be on the lookout for the factors we discussed that can cause it. Remember to keep basics in mind and keep all investments stress-free.
If you have more questions or other investment concepts that you find complicated, log onto www.angelbroking.com for podcasts, blogs, videos and other informative content that will help you on your personal investment journey.
As always, Happy Investing!