What is the difference between slippage and trading? How to avoid slippage in the cryptocurrency market?
What is slippage? Why does the buying and selling difference occur?
The spread is the distance between the highest bid and the lowest ask price in the order book for an asset.
In traditional markets, this spread is often created by market makers or intermediary liquidity providers. In cryptocurrency markets, it occurs as a result of the difference between the limit orders of buyers and sellers.
If you want to buy an asset at the market price in real-time, you must buy it at the lowest asking price given by the seller. If you want to sell instantly, this time you have to sell at the highest bid price.
In active markets, this difference is low. Since the volume of transactions in the order book is high, the activities of buyers and sellers do not significantly affect the price of the asset. When the spread is larger, executing large volume orders will cause price fluctuations.
What is slippage?
The difference between the initial expected price and the actual transaction price is called slippage.
Slippage is the price movements that take place between the time the order enters the market and the execution of the transaction, as a result of which investors have to agree on a price different from what they originally wanted.
Slippage, which can happen in all markets, occurs more frequently and larger in crypto markets (especially decentralized ones) due to high price volatility.
In addition, problems such as low volume and liquidity increase the likelihood of slippage.
For example, you want to place a buy order greater than $100, but the market does not have the liquidity to execute this order at the price you want. So you have to take orders over $100 until your order is full. As a result, the average price of your purchases will be over a hundred dollars, which is what we call a slippage.
So when you create a market order, the exchange automatically matches your buy or sell to the limit orders in the order book. The order book will match your orders with the best price, but if there is not enough volume at the price you want, you will start to rank up. As a result, you may encounter unexpected prices.
Benevolent and malignant slippage
There are two types of slippage, positive and negative. If the price at which the trade is executed is lower than the price on the buy order, it is called a positive slippage as investors are buying cheaper than they expected.
If the realized price is higher than the price on the buy order, it is called a negative slippage because it affects the investors badly. The opposite is true for sell orders.
Too many slippages can hurt frequent traders. Although slippage cannot be eliminated, to reduce this, traders may choose to execute limit orders rather than market orders.
Some exchanges allow setting a tolerance level to limit the slippage rate. On the other hand, if the slippage tolerance is kept low (0.1 percent to 5 percent is normally used), there is a chance that the transaction will not happen at all and miss a big opportunity. Slippage can suddenly turn into a nightmare for inexperienced investors. That's why it's important to understand the price volatility of both the cryptocurrency and the stock market.
Here are some tips to minimize slippage rate:
Use limit orders. Thanks to limit orders, you can get the price you want or even better. Even if you sacrifice the speed of your transaction, you will get rid of the negative slippage rate.
Break your big orders into small pieces. Keep a close eye on the order book and try not to place orders larger than the current volume.
Even a single transaction on illiquid assets can generate a small amount of slippage. However, if you make a large number of small transactions, the price of your transactions will be affected.
Beware of transaction fees found on decentralized exchanges. Some networks reduce the slippage rate, while others may charge transaction fees that can reset earnings.