So, you’ve taken your first step into the world of cryptocurrencies. As you learn more about this industry, you will encounter numerous technical phrases and concepts that may need clarification.
Slippage is an example of the somewhat confusing crypto lingo. It is crucial to understand how slippage in crypto works since it has the potential to impact the earnings you make from trading significantly. But there is no need to be concerned about it since we are here to demystify this concept for you and make it abundantly clear.
Defining Slippage in Crypto
Investors expect to buy different cryptocurrencies at the same price (or estimate) they initially agreed to. However, the expected value of an item rarely coincides with the actual value at which you may make a sale. The significant volatility of the cryptocurrency market causes this price fluctuation.
Slippage can be defined as the difference between the expected price of a contract and the spot price at which the trade is actually made.
Even a brief delay between a purchase and the time it is processed can cause a noticeable shift in market pricing. These shifts can result from an increase or decrease in liquidity, a shift in the balance between the supply and demand of a digital asset, or even just a significant piece of news affecting the market.
Types of Slippage
Slippage is a regular occurrence in markets that are characterized by high levels of price volatility or low levels of trade volume. Positive and negative slippages are the two types of price discrepancies that can occur.
Positive slippage occurs when the actual executed price for a purchase order is lower than the anticipated price for that transaction. This gives traders a better rate than they planned to receive when they placed the buy order.
An example of negative slippage is when a purchase order is fulfilled at a higher price than anticipated, giving the trader a less favorable price compared to what they had hoped for. When it comes to sell orders, you should expect the opposite.
Whatever the case, the slippage tolerance will affect the actual price you pay when buying or selling a digital asset.
Why Does Slippage in Crypto Occur?
When it comes to the crypto markets, there are a few potential causes of slippage. The primary justification for the slippage is that cryptocurrency markets are still young and developing compared to traditional asset classes such as equities and commodities. As less money moves around, prices may swing wildly, and the slippage may increase.
Furthermore, values in cryptocurrency marketplaces are frequently represented in fiat currencies such as the US Dollar or the Euro, another factor contributing to price slippage in these marketplaces. This factor indicates that when the market for fiat money is turbulent, it might result in increasing slippage in the cryptocurrency markets.
Leverage is yet another factor that may contribute to slippage in the cryptocurrency markets. Taking advantage of leverage can amplify not just gains but also losses, which can result in more noticeable price fluctuations and higher degrees of slippage.
Last but not least, we need to factor in the market liquidity. When dealing with cryptocurrencies, market liquidity is one of the essential aspects that might affect slippage. When we talk about a market having great liquidity, we are referring to one where there are numerous buyers and sellers and where huge orders can be performed without the price being significantly affected.
Contrarily, low liquidity in a market indicates that fewer buyers and sellers compete to execute a trade, making it more susceptible to price swings caused by large orders.
Slippage is less likely to happen when the cryptocurrency market is active and liquid. This is due to the fact that the “bid-ask spread,” which refers to the gap between the maximum price a buyer is prepared to shell out and the lowest price a seller is ready to take, is very small. As a result, large orders can be fulfilled with minimal impact on the market price.
When the cryptocurrency market is less liquid, on the other hand, there aren’t as many orders in the order book, the bid-ask gap is larger, and huge orders have the potential to impact the price, which might result in slippage.
Ways to Prevent Slippage in Crypto Trading
Those who trade often might lose significant money if there is high slippage. You are in luck, as there are a number of ways in which you can avoid incurring losses as a result of the significant gap between the prices of a traded asset.
Slippage Tolerance Control
Using slippage tolerance control, you can limit the amount of slippage that occurs. Some marketplaces offer this functionality. This functionality enables you to focus on either positive or negative slippage in your trading performance, thus giving you more power to control it.
A transaction’s slippage tolerance refers to the maximum allowable difference between the price at which the order was filled and the price at which it was placed. An investor who wants to buy $100 worth of Bitcoin, for instance, and has a slippage tolerance of 0.50% can specify that they want their order to be executed only if the actual price of Bitcoin is within $0.50 of their target price.
When you use a slippage tolerance, you tell your broker that you are willing to accept a certain amount of price movement that is different from what you had anticipated having your transaction successfully executed.
As a result, the broker will fill your order based on the criteria you specify. In the event that the market price fluctuates by more than your specified amount, say 0.15%, your request will be canceled. This is done to maximize the likelihood of your trade’s success.
Use Limit Orders Instead of Market Orders
Slippage can be minimized or eliminated entirely if traders avoid placing market orders and instead use limit orders, which reject a less-than-favorable price. So, while utilizing your trading platform, place limit orders rather than market orders on your trading platform wherever possible.
Using a limit order to conduct a trade means you won’t have to worry about the ups and downs of the market and will remain focused on performing purchases and sales at the agreed-upon price.
With a limit order, you are able to determine the price at which you want to purchase or sell the asset. If the market hits the price you have specified as your limit, your order will be carried out, and vice versa. Your order will not be fulfilled if the market does not meet your limit value.
Using Stop-Loss Orders
Slippage can also be mitigated with the use of a stop-loss order, which is an optional feature on some trading platforms.
In cryptocurrency trading, a stop loss is an order that informs the broker of the client’s decision to exit the market. By placing a stop-loss order, you tell your broker to bail out of a transaction if the price drops below the stop-loss value you specified, and they do it automatically if that price is hit. This way, you’ll be protected against a financial loss in case of a wide price discrepancy of the traded asset. On most of today’s innovative trading platforms, this is an automated procedure completed in a short amount of time.
The stop-loss order has to be set up in advance, and the trading platform will handle the rest. This frees you from having to monitor the stock market constantly.
In addition, a stop-loss order allows you to predetermine the level of financial risk you are willing to take, making engaging in responsible financial management possible.
Conclusion
A slippage in crypto happens when a contract’s actual price differs from the expected price. This can happen as a result of volatility in the market or delays in the execution of the contract. Higher slippages should be anticipated as a result of the extraordinary volatility that characterizes the cryptocurrency market, alongside the increased risk of a financial loss.
To keep your losses to a minimum, it’s important to figure out the slippage on every trade. Understandably, this can be hard to do when dealing with something as volatile as cryptocurrencies.
However, if you are familiar with the mechanisms underlying price variations and have implemented measures to reduce your sensitivity to slippages in your trading, you can use them to your advantage.