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Understanding Slippage and How to Avoid it

In this post we will be discussing slippage and its importance for traders in order to set orders correctly which will impact trade and profit outcomes as well as for managing risk when trading.

We will also get into important complimentary terms and concepts such as market price and limit orders.

Concepts such as slippage, market price and limit orders are all part of the fundamental knowledge in day trading and financial markets that all successful traders must have in order to become profitable.

So let’s discuss these concepts beginning with slippage and also discussing market price and limit orders so you can get the full picture for the benefit of your trading success.

What is slippage in trading?

Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed. It typically occurs in fast-moving markets or when there is low liquidity. It can happen in both directions, either in favor of the trader or against them.

For example, if you place a market order to buy a stock at a certain price, but by the time the order is executed, the price has moved higher, you experience positive slippage. Conversely, if the price moves lower before your order is filled, you experience negative slippage.

Slippage can impact traders’ profitability, especially in highly volatile markets or during periods of low liquidity when there are fewer buyers and sellers. Traders often use limit orders (which we will discuss further on in this post) to try to minimize it by specifying the maximum price they are willing to pay (or the minimum they are willing to accept) for an asset.

What is Market Price?

Market price and slippage are closely interrelated in training. So let me break it down in the simplest way possible.

Market price is the reference point for executing a trade. It is the price which buyers and sellers agree upon at the time.

Slippage is deviation from the market price. It occurs when the actual price you wanted to get in with differs from the expected price at the time you entered a trade.

This happens a lot in fast moving markets and low liquidity markets where slippage is more likely to happen.

Let me explain the market price in another way. You know when you go shopping and you find this super hot dress then look at the price tag? Well, that’s the market price. You pay what you see!

This is probably the easiest concept of investing.

You find a stock or fund or futures entry point that is desirable to you and press buy/sell and that’s market price.

how to avoid slippage
Slippage is important to understand for traders in order to set orders correctly which will impact trade and profit outcomes as well as for managing risk

However, price slippage happens.

With the market being so dynamic and constantly moving up or down when you press the button at market price, chances are you will get a slightly different rate.

A good way to look at it is like this – the dress you want is $500. You get to the counter and end up paying $540 which is including tax.

There are no taxes in equities or shares, but slippage works similarly to this. You end up paying a little more than the market price due the volatility of the prices.

So you should have a better understanding why it’s so important for traders to be aware of and account for slippage but let’s make it a bit more clear.

5 Key Reasons Why It’s Important for Traders to Understand Slippage 

1.Risk Management

By understanding slippage, traders can better manage their risk exposure and make informed decisions about trade entries and exits which will positively impact profitability.

2.Realistic Expectations

Knowing about slippage helps traders set realistic expectations about trade outcomes. It prevents them from being surprised or disappointed when actual execution prices deviate from expected prices.

3.Order Placement Strategies

Traders can adjust their order placement strategies to minimize slippage. For example, using limit orders instead of market orders can help control the price at which orders are executed.

Traders can adjust their order placement strategies to minimize slippage. For example, using limit orders instead of market orders can help control the price at which orders are executed.
Traders can adjust their order placement strategies to minimize slippage. For example, using limit orders instead of market orders can help control the price at which orders are executed.

4.Understanding Market Conditions

Awareness of slippage allows traders to assess market conditions effectively. They can gauge the impact of volatility, liquidity, and order size and adjust their trading strategies accordingly.

5.Risk Mitigation

Slippage can be a significant risk factor, especially in fast-moving or illiquid markets. Understanding it empowers traders to implement risk mitigation strategies such as using appropriate order types, setting realistic price targets, and managing position sizes.

How to Avoid Slippage and Enter at the Price You Want?

Managing slippage is crucial for traders to protect their trading capital and improve overall performance. 

So let’s discuss how best to avoid it.

Using Limit Orders

One of the most effective ways to mitigate slippage is by using limit orders instead of market orders. With a limit order, traders specify the price at which they are willing to buy or sell an asset. This helps control the execution price and reduces the risk of experiencing significant slippage.

Traders can set limit orders based on their analysis of support and resistance levels, technical indicators, or fundamental factors.

Trading During Times of Higher Liquidity

Slippage tends to be more pronounced in markets with low liquidity, where there are fewer buyers and sellers. To reduce slippage risk, traders can focus on trading during times of higher liquidity, such as during active trading hours or when major financial centers are open.

Higher liquidity typically leads to tighter bid-ask spreads and smoother order execution, reducing the likelihood of significant slippage.

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Avoiding Highly Volatile Assets Without Appropriate Risk Management

Highly volatile assets can experience rapid price movements, increasing the potential for slippage. Traders should exercise caution when trading such assets and implement appropriate risk management measures.

This may include using smaller position sizes, setting wider stop-loss and take-profit levels to account for volatility, and avoiding trading during periods of extreme market volatility unless their trading strategy is specifically designed to capitalize on such conditions.

Using Stop-Loss Orders Wisely

Stop-loss orders are essential for managing risk, but they can also be a source of slippage if not used wisely. Traders should consider setting stop-loss orders at meaningful levels that align with their risk tolerance and market analysis. Using a combination of limit orders and stop-loss orders can help mitigate slippage while still providing downside protection.

Monitoring Market Depth and Order Book

Traders can benefit from monitoring market depth and the order book to gauge liquidity levels and potential slippage risks. Understanding the current market conditions, including bid and ask sizes at various price levels, can help traders make more informed decisions about order placement and timing.

Slippage in Trading: Wrap-Up

When it comes to slippage in trading as long as you are doing market orders, it is difficult to completely avoid it.

Limit orders are one of the means to avoid slippage that was discussed in this post along with checking liquidity and market depth as well as knowing about the asset you are trading in terms of liquidity.

Slippage is a very important concept especially for day traders but for long term or even short term (not day trading) this doesn’t cause too much alarm and the difference in price is minimal.

NOTE: Slippage is not commissions. That is totally different and your commission rates are solely based on your brokerage/management firm.

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If you have any questions you can always ask me at traderchick.com and if you want to learn more trading strategies – check out MY Courses.

If you want to learn more about my journey and how I started day trading you can read it here or you can watch on my YouTube channel.

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