What are slippages in trading?

Slippage is the difference between the desired execution price and the actual executed price. It can be positive, negative or no slippage. Slippages are influenced by various factors like the order type, order size, liquidity of the instrument, volatility in the markets etc. In the context of algorithmic trading and execution, slippage refers to the difference between the signal price by the algo and the actual execution price of the broker.

Slippages is mostly prevalent in forex markets and stock markets but can happen in all buying and selling transactions irrespective of the instrument traded. ­­­­

Why it occurs:

Slippages generally occurs with market orders, during periods of higher volatility and low liquidity. It occurs when there is sudden change in the price at the time of order execution. In case of a market order, if the price moves from the desired range the order is executed at the next best available price.

The order size can also be a factor for slippage. It occurs when a large order is placed and the desired price is not achieved for all the quantities executed.

Broker’s execution speed and capability plays a crucial role in determining the level of slippages that can occur. If the execution is good, slippages can be minimized to a significant extent.

Low liquidity is a major factor which influences the slippages. If trades are placed in an instrument which has low level of liquidity and a greater bid-ask spread, slippages are inevitable.

Slippage – An example:

If you are placing a market order for 10 shares of Tata power while it is trading at ₹100 per share and it moves up to ₹102 and gets executed at that price, you have a negative slippage of ₹2. If it has went down to ₹98 and got executed at that price, you’d have a positive slippage of ₹2. Desirable transaction cost is 10 x 100 = 100 but executed total transaction cost is 10 x 102 = 1020, which indicates a slippage loss of ₹20

Slippages are generally considered to be negative, positive slippages can also occur making it favourable. In percentage terms, if someone has a slippage tolerance of 2%, it means that the person is comfortable with a slippage loss of ₹2 on transaction of ₹100.

How to minimize slippage losses:

While in most scenarios, slippage can’t be totally avoided, it can be it can be minimized significantly by following these steps:

Using Limit Orders:

The only option through which one can avoid slippage all together is using limit orders. Limit orders are executed only when the specified price is met with. The downside to this is the order not being executed all together, as there is possibility of the specified price not being achieved or met with.

Trading in liquid instruments:

Instruments with healthy liquidity and trading volumes have a narrow bid-ask spread which minimizes slippage to a great extent.

Avoid volatile market scenarios:

Volatile market scenarios amplify the level of slippages that can occur. So, avoiding to trade in times of high volatility like expiry days can significantly reduce the slippage risks.

Conclusion:

Now you are aware of the fact that slippages are prevalent irrespective of the instrument and market, one can minimize his/her slippages by following the above-mentioned steps and drawing out a tolerance limit for slippages.