What is Slippage in Cryptocurrency Trading?

When trading crypto, you must have noticed that when you place trade orders, they are not always executed at the exact price you want. Sometimes the order can be executed at a higher price and other times it can be lower. This occurrence is called price slippage.

But why does slippage occur and how can you prevent it?

What is skidding?

Traders usually trade with specific prices in mind. You don’t just open a card lineup and trade without any reason or purpose. Whether you buy or sell a cryptocurrency, you want to do it at a certain price, which is sometimes not possible due to slippage.

When slip occurs, you have to settle for a different price than the desired price you ordered. The situation is usually caused by a price shift between when you place the order and when it is executed.

Slippages can be positive or negative based on their effect on your trades. Positive slippage gives you an advantage in the market because your order will be executed at a better price than the price you have placed. For example, if you execute a buy order and it is executed at a lower price than you ordered, it puts you in better shape, giving you a better buy rate and making more money.

Negative slippage is the exact opposite of positive slippage. Due to the price change, your order will receive a lower price than you originally ordered. An example is when you try to sell an asset, say 1 LTC, for $50, but the order is executed for $48. In this case, your trade was executed at a lower price.

What Causes Slippage in Crypto Trading?

Price volatility and low liquidity are the two main causes of crypto market slippage.

Price volatility

The crypto market is characterized by rapidly changing asset prices. The volatile nature of the market makes orders prone to slippages. In addition, factors such as supply and demand, investor sentiment, user hype, and government regulations influence the price of cryptocurrencies. The market is easily affected by these factors as it is relatively new.

Low market liquidity

Some cryptocurrencies are not popular; so they have low liquidity, making them very prone to slippage. If a token has low liquidity, there are few buyers and sellers. So if you place an order, especially a large order, there is a chance that the price will change when the system executes the order, pushing the price out of your execution.

The more liquid a market, the smaller the chance of large price drops. Let’s say you want to buy a unit of a crypto asset for $200. Once you place the trade, it will be executed at the best price in the order book. If the current best order has only 0.5 units of that asset, it means the order cannot be fulfilled; the system then searches for the next level to see if the order can be renewed. As the price increases to execute the order, the possible execution price also starts to increase. This means that you have to pay more to fulfill the order.

In this case, the best market price is a worse price.

What is slip tolerance?

You can control your slip exposure by setting a slip tolerance percentage. Setting your slip tolerance to a certain percentage means that you will feel comfortable changing the price by that percentage, both up and down.

For example, if you set your tolerance to slippage at 3% and you want to buy $100 worth of crypto assets, that means you are comfortable trading from $103 as the maximum or $97 as the minimum price. The exchange will not execute the trade if the price drops to $104 or $96.

A very low slip tolerance will cause a trade to fail if the price goes above the set percentage, as in the example above.

A high slip tolerance level ensures that your trades can be completed despite the price fluctuations. A high slip tolerance is usually better used when trading a volatile market or crypto projects with lower liquidity and high trading volume, much like a crypto launch project.

However, high slip tolerance rates can expose you to front running. Front running is an illegal process of profiting from information to buy and sell securities upfront. The attacker sees a pending transaction and then places a much larger transaction before and after the pending transaction. This practice forces you to accept the highest possible slippage price based on your setup, and the frontrunner takes advantage of the difference in value.

How to prevent slipping

Slippages can cost you a lot of money, especially if you are a short-term trader who transacts a lot. However, there are ways to eliminate or at least reduce the effect of slippages from your trades, and we’ll discuss them below.

One way to avoid slippages is to trade with limit orders. Slippages can only occur when you use market orders. Market orders are a type of trading order that is automatically executed at the best market price. The use of limit orders guarantees that your order will be executed at the exact price you want and not at any other price as in the case of market orders.

An important limitation when setting limit orders is that they are not guaranteed to be executed; as such, you may miss the opportunity to enter a trade you desire.

Another way to reduce the effect of slippages on your trades is to trade in less volatile markets. This may sound impossible as the crypto market is generally volatile and price changes quickly. However, to avoid major slippages, be wary of trading during periods when some major events or announcements could affect the market. Such periods are characterized by extreme price volatility.

Investing in highly liquid assets can also reduce the effect of slippages in your trades as it will not be difficult to find matching orders.

Slippages are part of Crypto Trading

In the traditional market, timing major events and announcements is easier because they often follow a structured and scheduled calendar. However, to a large extent, the crypto market is not yet that structured and stable, as an influencer’s social media activity can change the price of a token in no time. As a result, it is difficult to time some events that can make the market more volatile.

There are many cryptocurrencies with low liquidity and it is difficult to escape slippage when trading them. In addition, it can be impossible to trade with limit orders every time, especially if you are a short-term or daily trader.

As much as market orders are prone to slippages, the slippages may not matter much if the price differences are minimal. If your strategy requires immediate execution of trades, you may begin to view the price differentials as fluctuating costs of executing trades, which should be kept as low as possible.

Leave a Reply

Your email address will not be published. Required fields are marked *