Slippage in trading is the difference between the expected price of a trade and the price at which it actually executes. This happens mainly during periods of low liquidity or high volatility in the market, often leading to a worse price (negative) and sometimes a better price (positive) than desired, which in turn impacts market orders.

It may also happen due to major news or announcements, market openings, and sudden market gaps.

So, the types are negative slippage (buying at a higher price or selling at a lower price than anticipated) and positive slippage (buying at a lower price or selling at a higher price than anticipated). Let us learn more about slippage in trading below.

What is Slippage?

Slippage is the difference between a trade's expected price and the actual price at which it is executed, often more pronounced during periods of low liquidity or high market volatility. It leads to a quicker but sometimes less favourable execution price and is common in low-volume, high-frequency, or fast-moving markets. Let us take an example to understand the concept.

Suppose you wish to purchase shares of a company at ₹100 and place a market order when you see the prices of the same at ₹100. However, since prices are moving quickly, your order is ultimately processed at ₹101 per share, so you end up paying ₹1 more per share than expected.

Positive Slippage vs Negative Slippage

Let us take a closer look at both positive and negative slippage below:

Positive Slippage:

• It happens when the execution price crosses the intended price, thereby benefiting the trader.
• Buy order: Suppose you place a buy order at ₹100, but it executes at ₹98.
• Sell order: Suppose you place a sell order at ₹100, but it executes at ₹102.
• The outcome is a higher profit or reduced costs.

Negative Slippage:

• It is when the execution price is much worse than the requested price.
• Buy order: You place a buy order at ₹100, but it executes at ₹103.
• Sell order: You place a sell order at ₹100, but it executes at ₹97.
• The outcome is higher losses or increased costs.

Why Does Slippage Occur

Slippage occurs when a market order executes at a price different from the anticipated price, typically during periods of low liquidity, high volatility, or rapid market changes. It may happen because the price moves between the time an order is placed and when it is filled, mostly due to fast-moving markets, large, illiquid orders, and major news updates. Let us look at these reasons below:

• Higher volatility: Rapid price fluctuations mean the price at which you order the asset may not be available by the time the order reaches the exchange.
• Lower liquidity: If there are insufficient sellers or buyers at your desired price, then the order will slip to the next best available price.
• Big order sizes: A huge order may surpass the available volume at a particular price point, thereby forcing the broker to fill the order remainder at higher (or lower) prices.
• Gaps in the market: Major news updates, earnings reports, and weekend gaps may trigger price jumps, thereby bypassing intermediate levels and causing orders to be filled at less favourable prices.
• Technical latency: Delays of even microseconds in order execution in high-frequency trading environments may lead to price changes. This will result in slippage.
• Economic announcements: Major news, such as policy or interest rate decisions, may trigger rapid price changes.
• Market orders: Market orders focus on speed over price, unlike limit orders. This makes them vulnerable to slippage.

How Volatility and Liquidity Affect Slippage

Slippage increases during periods of high volatility and low liquidity. Here's how these two factors affect it:

Volatility:

• Rapid price movements: Highly volatile markets see prices change in seconds between the moment an order is placed and when it executes. This may lead to higher slippage.
• Events and major news: Key economic announcements or updates may trigger significant volatility, increasing the risk of considerable slippage.
• Quick market execution: In fast-moving markets, orders are executed in a particular sequence. This allows prices to move even further before your order fully executes.

Liquidity:

• Thin markets: Lower liquidity means fewer participants on the opposite side of the trade. It may lead to delays that enhance slippage.
• Large orders: More liquidity is required for large orders to be filled at a single price. However, in low-liquidity environments, large orders simply walk the book, i.e., execute at progressively worsening prices.
• Bid-ask spread: Low liquidity often leads to wider bid-ask spreads, thereby increasing slippage costs when using market orders.

Market Orders, Limit Orders, and Slippage

Here's looking at these vital concepts in more detail below:

Market Orders

Used for speed to guarantee that a trade fills immediately. The only drawback here is the absence of any price control. This means that you may buy higher or sell lower than expected in fast-moving markets.

Limit Orders

They are used to control costs by setting a specific price limit. A buy limit will execute at this price or lower, while a sell limit will execute at this price or higher. This prevents any negative slippage but does not guarantee execution.

Slippage

It is the difference between the expected price of a trade and the actual price at which it is filled.

Slippage in Stocks vs F&O vs Forex/crypto

Let us look at a brief comparison of slippage for these asset classes.

So, as you can see, highly liquid stocks have narrow spreads, thereby leading to minimal slippage. Futures are highly liquid, although options (especially far-month or out-of-the-money contracts) may witness considerable slippage due to wider bid-ask spreads.

Large orders may also eat into the order book, triggering slippage. The Forex market is also highly liquid, thereby keeping slippage low for major pairs.