Slippage causes the trader to receive a result that is not at all what he expected.
Slippage can occur when a stop-loss order (or other conditional order) is not followed through on. As a result, the price exceeds the set value and trades higher/lower depending on the direction of the placed order. Another cause of slippage could be the actions of shady exchanges - this is pure fraud, but fortunately, it is uncommon.
Slippage is common in all markets, including the cryptocurrency market. This is most common with low-liquid assets, but it also occurs frequently on decentralized exchanges (DEX).
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When does slippage occur?
Slippage occurs when the final price of a transaction differs from the trader's expectation. However, it is not always detrimental to traders. It could be negative, and you could lose money. However, it can also be positive because there is a chance of getting a better deal. So, if you want to buy 100 coins for $5 each, but the asset's price drops to $4.50, your order will be $450, not $500, indicating that you got a better deal. However, if the price rises, there will be negative slippage. Assume that instead of $5, the asset now costs $5.50. In the end, you'll have to spend $550 rather than $500.
Causes of slippage
Knowing the cause of this phenomenon will make it clear how to reduce the chances of suffering a loss.
Low liquidity
Liquidity is what allows you to buy and sell an asset without affecting the current price. The primary cause of slippage is a lack of liquidity in the traded pair. Because liquidity is a relative value rather than an absolute, a trader or investor must determine the presence or absence of proper liquidity in an asset. Even at the planning stage of a transaction, otherwise, serious consequences may result.
Gap in spread
The spread is the price difference between the nearest order in the order book to buy and sell. The greater the liquidity in a pair, the smaller the spread, and vice versa. A wide spread indicates that there are few participants as well as orders. While a market order is being formed, another order placed by another participant may be added to the spread. As a result, a large order may be withdrawn, causing slippage. When there are many trading participants, a few canceled orders do not affect the order book's liquidity, and the spread is minimal.
High volatility
High volatility indicates a sharp price change in one direction or the other - aggressive growth or a significant decline in the price of an asset. During periods of high volatility and market tension, many participants may act impulsively. It raises the price movements.
Furthermore, conditional orders, such as stop loss or take profit, are typically placed near important price zones, which increases the impulse price movements in one direction or the other. As a result, a newly created market order will compete for liquidity in the order book. If your market order is executed before another, you will open or close on the next available order.
How to avoid slippage
Always check liquidity before placing an order, especially if you are trading small amounts of altcoins. An incorrect assessment of liquidity when planning a deal can be a major issue.
Choose liquid assets and the most liquid platforms, and the risk of serious slippage is reduced.
Limit orders protect you from slippage because this phenomenon does not occur with these orders.
Increase the gap to the maximum acceptable value when using conditional order types so that the order is triggered by the market rather than sent to the order book to create liquidity.
Conclusion
Now that you've learned about slippage, you can put it to use. Slippage can occur on any asset or exchange from time to time, and the less liquid the pair is, the more likely it is. Be cautious and avoid dealing with assets that have no liquidity at all. It is probably not a good idea to use this approach as your primary trading strategy because it occurs infrequently. However, as an additional way to make money with minimal risk, this option can be considered; however, all potential risks must be considered.
Have you heard of trading slippage? Please share your thoughts in the comments!
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