What is Slippage in Crypto: Impact, Strategies, and Risks

by | Mar 6, 2023 | Autowhale

Crypto trading has grown in popularity over the last few years. Many individuals are looking to gain profit and a wide interest in blockchain technology.

A better understanding of what is slippage in crypto is important, particularly as the crypto market continues to attract new traders both individuals and organizations. Whether you’re a business entity or an individual trader, comprehending slippage is vital to maximizing your gains from crypto trading.

In this article, we will learn the concept of slippage in the crypto market, understand its impact on trading, and strategies to minimize its effects.

What is slippage in Crypto?

Slippage in crypto is defined as the discrepancy between the desired price of a trade and the actual price at which it gets executed. This usually occurs when the order placed doesn’t go through immediately or if the trade goes through at a different price than the order placed. 

Slippage often happens in crypto markets that are highly volatile, have low trading volumes, or when traders place orders that are bigger than what the market can handle right away. 

Example of Slippage

How slippage occurs

In the table that is shown above, there are two instances in that slippage can occur. It can be on both buy or sell orders. For example, the trader places a buy order of 100 units of crypto for $10 per unit. But when the order is executed, the real price is $10.50 per unit, so there is a $0.50 per unit slippage. 

In the second case, the same trader placed a sell order for 50 units of cryptocurrency at a price of $20 per unit.

The order, however, is fulfilled at a lower price of $19.50 per unit, resulting in a $0.50 per unit slippage. This table illustrates how slippage can affect both buy and sell orders.

Factors that affect slippage in crypto trading

Aside from understanding what exactly slippage in crypto is, traders must also know the factors that affect slippage. In crypto, trading slippage may be caused by a variety of factors, including market volatility, insufficient liquidity, order size, and exchange technology. Price swings and broad bid-ask spreads may emerge from high market volatility, making it more difficult to execute deals at targeted pricing.

Slippage may also occur when there aren’t enough buyers or sellers to match a trader’s order. Since the market may not have enough liquidity to fulfill the whole order at the given price, large order sizes might induce slippage.

Moreover, slippage may be caused by exchange technology, since delays in order execution can cause prices to fluctuate before a deal is performed.

Risks associated with slippage in cryptocurrency trading

Due to slippage, a trader can run the risk of unanticipated losses. Slippage may cause traders unexpected losses. Due to market volatility, liquidity, and other variables, transaction prices might differ greatly from predicted prices. Slippage may create unexpected and especially grave losses for leveraged or large-position traders.

Slippage and unanticipated losses might lower profitability and it may reduce total trading earnings for traders. This can occur when a sell order’s price is lower or a buy order’s price is higher. If a trader plans to sell a cryptocurrency for $100 per unit but only sells it at $90 owing to slippage, their earnings will decrease.

Slippage also increases trade expenses and may increase trading costs and commissions. Traders might also be forced to execute deals at higher prices, increasing costs and commissions due to slippage and frequent traders might easily lose money due to these charges.

Another factor to consider is that slippage complicates risk calculation and position management. Traders who can’t gauge risk may take on too much of it which may result in losses or margin calls. Such margin calls happen when a trader does not have enough funds in their account to cover losses and the broker needs them to deposit additional cash to preserve their holdings.

Pre-trade preparation to reduce slippage

Pre-trade preparation is one of the strongest techniques to minimize slippage in cryptocurrency trading. This involves thoroughly researching market circumstances, comprehending the bid-ask spread, and establishing realistic trading objectives. By understanding market dynamics, traders are able to predict future slippage and change trading techniques appropriately.

The bid-ask spread is the difference between the highest price a buyer is prepared to pay and the lowest price a seller is ready to accept. By monitoring the spread, traders may determine the optimal time to execute transactions in order to reduce slippage.

Tips for executing trades with minimum slippage

Instead of using market orders when trading, another way is utilizing limit orders to trade with the least amount of slippage. A limit order refers to a type of order where a trader sets a pre-determined price at which they want to either buy or sell a crypto asset. A trader can set a certain price at which they want to buy or sell an asset with a limit order. Unlike in traditional fiat markets, in crypto trading, there is often no limit to limit trading which can be a great advantage if used wisely. Traders can ensure that their trades happen at the price they have set or trades don’t happen at all. 

A trader can control the amount of slippage when using limit orders for trading in the crypto sphere by setting prices in line with the current market rate. This prevents surprises that come from market orders like pricing discrepancies or the risk of trades being filled at unforeseeable prices. Limit orders are particularly useful during times of high volatility when prices are rapidly increasing or decreasing.

For example, the trader wishes to purchase 1 ETH at a maximum price of $1,800 per ETH. They put a limit buy order on the ETH/USD pair, indicating the maximum price they are prepared to pay and the quantity of ETH they want to purchase.

If the ETH market price falls to or below $1,800, the order will be immediately filled and the trader will pay $1,800 for 1 ETH. If the market price does not reach $1,800, the order placed will stay open until either it is filled or until the trader cancels the order. More on limit order here.

Additionally, selecting crypto exchanges and crypto assets with high liquidity can help reduce the risk of slippage.

Conclusion

In the world of cryptocurrency, slippage is a prevalent vulnerability that affects many investors, causing them to bear additional costs. While slippage occurs frequently among traders, those who possess a solid understanding of what slippage is in crypto trading gain an edge in designing and deploying trading strategies, as it can greatly impact both profitability and risk management.

None of the content above is financial advice and is for educational purposes only. Find more content on algorithmic trading software, crypto market making and market microstructure on Autowhale’s blog.

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