What Is Slippage?
Slippage is the difference between a trade's expected or requested price and the price at which the trade is effectively executed. It typically occurs in markets experiencing high volatility or low liquidity.
The slippage percentage quantifies a given asset's price fluctuation between the order placement and execution. Crypto markets can be highly volatile, with significant price fluctuations in short periods, and therefore prone to price slippage.
What factors can cause slippage in crypto markets?
Slippage usually occurs due to two main reasons:
1. Low or lack of liquidity on an exchange
Suppose you place a large market buy order of 100 BTC for $20,000 per BTC on an exchange with low liquidity. A lack of liquidity means that your whole order can't be filled at the price you want. Some of your order will have to be matched with sell orders above $20,000 to be 100% executed.
In our example:
- 150% of your order gets matched with a sell order at $20,000
- 25% of your order gets matched with a sell order at $20,001
- The 25 BTC is matched with a sell order at $20,002
Your average price will be $20,000.75, higher than $20,000, causing negative slippage of $75
2. High Volatility
Due to high volatility, slippage can arise when the market price shifts post-order placement. Suppose you want to place the same market buy order as in our previous example of 100 BTC for $20,000 per BTC.
At the order placement time, BTC bid/ask prices are posted as $19,990.50/$20,000 on the order book.
In volatile markets, price fluctuations can happen quickly, even within the few seconds required to fill an order. Besides, the order can impact the market by providing information that high-frequency traders can take advantage of when frontrunning.
In our example, high volatility in the BTC market incurs a fast price shift caused by high-frequency trades before the order gets filled. This results in the bid/ask prices changing to $20,000.5/$20,001. The order is then filled at $20,001, incurring an extra cost of $1 per BTC for a total of $100 negative slippage on the 100 BTC order.
How can I minimize exposure to slippage?
Use limit orders instead of market orders
A market order is an order to buy or sell a stock at the market's current, best-available price. It aims to ensure an order's execution but offers no guarantee to fill at a specified price. Price fluctuation occurring after you place the order can affect its execution price.
A limit order, however, will only fill at a requested price. This means you will trade your asset only at your requested price rather than a price set by the market. Note that this doesn't guarantee your whole order will fill at your requested price, and only a partial amount may be executed.
Trade on exchanges with high liquidity and during low volatility periods
As slippage commonly happens when volatility is high and liquidity is low, trading on exchanges with low liquidity may increase your exposure to potential slippage. Using high-volume exchanges with deeper liquidity may help mitigate that risk. Likewise, trading during low volatility periods will reduce the likelihood of unfulfilled/partially filled orders at the initial set price.
Adjust your slippage tolerance
Slippage tolerance is the maximum percentage price difference you're willing to accept before your order stops filling or is cancelled. Exchanges often integrate this feature as a way for traders to hedge themselves against significant price changes in the market when they place orders.
Slippage tolerances features are typically available in decentralized exchanges (DEX), where slippage occurs more frequently. Similarly, the USDⓈ-M Lite Trading Mode on Binance App includes the feature by default for its users, as shown below:
Slice large orders into smaller ones
Large orders are more prone to slippage risks given the typically increased latency of their execution and their need to absorb more liquidity. Instead of placing a large bulk order, spreading its execution over time and across exchanges gradually over time can effectively help cope with slippage risks. You can also use Algorithmic Trading Strategies (ATS) like VP and TWAP to help efficiently execute your orders and avoid slippage in the same manner.