Slippage

Slippage occurs when the average price of a trade is different than what was initially expected. Slippage usually happens when using market orders, often because there's not enough liquidity to fill your order or the market is volatile, causing the final order price to change.

So, instead of getting the exact price you want, slippage may cause the trade to cost more or less. Traders try to reduce slippage by breaking big trades into smaller parts or using limit orders that let them set a specific price for buying or selling.

Bid-Ask Spread

To fully understand slippage, it's essential to understand the bid-ask spread. This spread represents the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask). The bid-ask spread is influenced by factors such as market liquidity and trading volume. More liquid assets, like Bitcoin, typically have a smaller spread due to a higher volume of orders in the market.

Slippage Example

Consider a scenario where a trader places a large market order at $100, but the market lacks the necessary liquidity. The order may get filled at prices above $100, resulting in an average purchase price higher than anticipated. This discrepancy between the expected and actual prices is what we refer to as slippage.

Positive Slippage and Slippage Tolerance

While slippage often implies a less favorable outcome for traders, positive slippage can occur if prices move in favor of the trader during order execution. Some exchanges allow users to set a slippage tolerance level, influencing how much deviation from the expected price is acceptable. This option is common on decentralized exchanges and DeFi platforms.

Balancing slippage tolerance is crucial, as setting it too low may delay order execution or cause the transaction to fail. Setting the slippage tolerance too high risks exposure to undesired price levels.

Minimizing Negative Slippage

Traders can employ strategies to minimize negative slippage:

Conclusion

It’s important for traders to understand the concepts of bid-ask spread and slippage to make more informed decisions and mitigate potential risks. The concept of slippage is especially important to those venturing into decentralized finance and decentralized exchanges.