Last Updated on October 16, 2023 by BFSLTeam BFSLTeam
Have you ever tracked the price of a stock and placed an order with a specific price in mind, only to see that it was executed at a different price level? Undoubtedly, this has happened to every active trader at some point during their journey. And there’s a technical term for it — slippage. In this article, we’ll take a deep dive into what slippage is, why it occurs and how you can minimise its effect on your trades.
What is Slippage?
Let us first define slippage. It is the difference between the expected price you have in mind when you place an order in the market and the actual price at which the order is executed. It occurs because the price of the stock or security changes quickly between the time of order placement and order execution.
Here’s an example of slippage in the stock market. Say a stock is trading at Rs. 200. Its price is on a downward trajectory, and you anticipate a support level at Rs. 195. So, when the price of the stock reaches that level, you place a buy order. However, before the order is executed, the stock price shoots up to Rs. 198, increasing the cost per share by Rs. 3 when compared to your expectations.
This is what slippage is. At first glance, Rs. 3 may seem insignificant. However, in the above example, assume that you planned to purchase 2,000 shares at Rs. 195. A slippage of Rs. 3 per share would add up to a total increase of Rs. 6,000 in your initial investment cost. This cuts into your net returns and reduces your profits.
What Causes Slippage?
Slippage may seem like an error in judgement on the trader’s part, but more often than not, it’s simply a product of the prevailing market forces. When the market is extremely volatile, the prices of stocks may fluctuate greatly, often skipping through multiple points in milliseconds. This makes it tough or even impossible to place an order at the exact price that you have in mind. Depending on the direction in which the price moves — or slips — you could find yourself facing reduced profits or even mounting losses.
This gives rise to two different kinds of slippage:
- Positive Slippage: This occurs when the price slips in a favourable direction. For instance, if you are placing a buy order and the price slips downward, it’s a case of positive slippage that gives you the opportunity to buy the asset at a lower price than expected. Similarly, for a sell order, positive slippage is when the actual price exceeds the expected price.
- Negative Slippage: Conversely, if the price of the stock moves in an unfavourable direction, we call it negative slippage. An example would be if the actual price is higher than the expected price for a buy order, or lower than the expected price for a sell order. In these cases, the profits dip or the losses increase.
Tips to Handle Slippage
You cannot eliminate slippage entirely, especially in a highly volatile market. However, the following tips can help you manage fluctuating prices more easily.
- Place Limit Orders
Limit orders allow you to have more control over the price at which your orders are executed. The order will only be fulfilled at the exact price you set as the trigger, so there is no slippage at all. However, there is always the risk of your order not being executed if the desired price is not met.
- Make Use of the Stop-Loss Facility
The stop-loss facility allows you to limit the downside associated with your trades. It lets you automatically execute an order when the price of a security reaches a specific level. This means that you may suffer the effects of slippage to a certain degree, but you can control the extent to which the actual price differs from the expected price.
- Wait for the Volatility to Subside
If the market is extremely volatile, it may be a better idea to wait for the uncertainty to subside before you execute your trade. This is particularly helpful if you are a beginner, because you may not be experienced at handling fluctuating prices easily.
Conclusion
Now that you are aware of the meaning of slippage, you can formulate your trading strategy to ensure that this parameter is accounted for. However, keep in mind that while it is not possible to avoid slippage altogether, you can use the measures outlined above to reduce the instances of slippage and the effects it has on your trades. Your trading strategy should also be flexible, so you can adapt it as the market changes to consistently minimise slippage.
