Definition
In finance, slippage refers to the discrepancy between a trade’s expected price and the actual price at which it’s executed. This difference can occur due to market volatility or changes in the liquidity of a security. Slippage can also be caused by orders being too large to fill at the desired price in the current market.
Key Takeaways
- Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed. This difference can occur due to market volatility or lack of liquidity.
- While often seen as a negative occurrence due to potential increase in transaction cost, slippage can also be positive if the actual execution price is better than expected. Nevertheless, high levels of slippage can cause significant impacts on trading profitability.
- Traders tend to minimise slippage by implementing different strategies such as ‘limit orders’, where a cap or limit is placed on the buy or sell price, or trading during busier market hours to ensure sufficient liquidity.
Importance
Slippage is a finance term that primarily refers to the difference between the expected price of a trade and the actual price at which the trade is executed.
It is important because it measures the efficiency of a trading strategy and affects the profitability of transactions, particularly in volatile markets or high-speed trading scenarios such as day trading or algorithmic trading.
Slippage can occur due to factors like market liquidity, order size, and the speed at which markets are changing.
It can also be an indicator of the effectiveness of a broker in carrying out transactions.
Understanding slippage can help traders in assessing risks, optimizing trading strategies, and selecting the most suitable brokerage services.
Explanation
Slippage in the financial world is essentially the discrepancy between the expected price of a trade and the price at which it actually executes. This difference doesn’t arise arbitrarily, but is a phenomenon primarily due to market volatility and liquidity. When an investor places an order for a security, be it stock, bond, or currency pair, often the market price changes before the order’s execution.
This results in the investor paying a price different from what was anticipated at the time the order was placed. This is called slippage and it is an indicator of the market’s liquidity and volatility. The purpose of keeping track of slippage is primarily to ensure efficiency and optimal execution of trades.
Fund managers and traders use slippage to analyze their trading performance and ascertain that they are not unnecessarily losing money due to poor execution. In high-frequency trading, where orders are executed within microseconds, even a small amount of slippage can impact the profitability of a trade significantly. Hence, it serves as a critical tool for investors and traders to measure and manage their transaction costs, as well as assess the overall effectiveness of their trading strategy.
Examples of Slippage
Trading Stocks: Perhaps the most common example of slippage occurs in the stock market. Let’s say an investor places a market order to buy 1,000 shares of a company when the price per share is $However, because the market constantly fluctuates, the price could quickly increase to $05 by the time the order is processed. Those extra 5 cents per share represent the slippage.
Currency Exchange: Another real-world example of slippage can be seen in currency exchange. Suppose a forex trader placed an order to buy €10,000 when the USD/Euro exchange rate isBut due to high volatility in the forex market, the exchange rate could rise to20 by the time the order is executed. This undesirable difference in the price is the slippage.
Futures Trading: In futures trading, slippage can occur due to the time delay between when a futures contract order is placed and when it gets filled. For instance, a commodity trader might place an order to purchase a futures contract at $Yet, due to high demand and volatile market conditions, the order may not get filled until the price has moved to $This $1 difference represents the slippage and can have a significant impact on the trader’s profits, especially if they’re dealing with multiple contracts.
Frequently Asked Questions about Slippage
What is Slippage?
Slippage is a term used in finance to describe the difference between the expected price of a trade and the price at which the trade is actually executed. It can occur at any time but is most prevalent during periods of higher volatility when market orders are used.
What Causes Slippage?
Slippage can occur due to several reasons, including market volatility, available liquidity, and the type and size of orders. It’s commonly observed in forex trading but can occur in other financial markets as well.
Is Slippage Always Negative?
No, slippage can be both negative and positive. Negative slippage means that your execution price is worse than the price you intended, while positive slippage means the execution price was better than the price you expected.
How Can Traders Minimize Slippage?
To minimize slippage, traders can consider using limit orders, which allow a trade to be executed only at a specified price or better. Also, trading in higher volume currency pairs or securities which usually have better liquidity might help reduce slippage.
Related Entrepreneurship Terms
- Market Order
- Liquidity
- Trade Execution
- Volatility
- Order Book
Sources for More Information
- Investopedia: This website offers a wide range of definitions and articles about various finance terms, including Slippage.
- Bloomberg: Bloomberg is a leading financial publisher which covers many different facets of the field, including terms like Slippage.
- Reuters: Reuters is another major financial publisher that offers many resources for learning more about various finance topics.
- Financial Times: Financial Times provides high-quality articles and resources on a wide array of finance-related topics.
