When engaging in cryptocurrency trading, it is common to notice that trade orders may not always execute at the desired price. At times, orders may be conducted at a higher or lower price, known as price slippage. Understanding and managing price slippage is an essential aspect of cryptocurrency trading.
What Exactly Is Slippage?
Slippage is the difference between the expected and actual prices of an executed trade. It can either be a positive figure (when buying) or a negative figure (when selling).
In cryptocurrency trading, slippage occurs when there is insufficient liquidity to fill an order at the desired price. As a result, the exchange may fill part or all of your order at a different price.
Slippage may cause prices to move either in your favour or against it. A “positive slippage” occurs when the order is executed at a lower price than requested, making you more money.
On the other hand, if the order is completed at a higher price than requested, this will be considered as “negative slippage”. This means that you will take a loss as the deal was executed at a higher price than you bought. For example, if you attempt to sell one LTC for $50 but end up with an order completed at $48, this is considered negative slippage.
What Are the Factors That Contribute to Slippage in Cryptocurrency Trading?
There are a few factors that can lead to slippage in cryptocurrency trading. These include:
- Market Volatility
The cryptocurrency market is characterised by highly volatile asset values, making it susceptible to order slippage. Additionally, various factors such as demand and supply, market sentiment, user enthusiasm, and government regulations all contribute to the fluctuations in cryptocurrency prices. Given the nascent nature of the market, these factors exert a significant influence on its dynamics.
- Level of Liquidity
Cryptocurrencies that are not widely used have low liquidity, which increases their risk of experiencing slippage. When a token has limited liquidity, there are not enough buyers and sellers to fill an order without some degree of price variation. This means when you place a large order, the cost may be different than what you initially expected due to the market’s inability to balance the order quickly and efficiently. As a result, investors must be aware of the liquidity risk associated with trading these types of tokens.
In a less liquid market, the chances of substantial price slippage increase. For example, if an investor is looking to buy 1 unit of a crypto asset for $200, if the best order in the order book only contains 0.5 units of that item, then it won’t be possible to fill the order. The algorithm will move on to the next level in search of a new order to fill. This means that the investor may have to pay more money for the same asset if there are few orders available at a lower rate.
How Does Slippage Tolerance Work?
Setting a slippage tolerance percentage is a great way to help manage your risk when it comes to price fluctuations. By placing your slippage tolerance to a certain percentage, you are essentially telling the system that you are comfortable with any price movement within that range – whether it be an increase or decrease in value.
For instance, if you are comfortable with a 3% slippage tolerance when purchasing $100 worth of a crypto asset, then the exchange will not execute the trade unless the price falls within that range. That means it should be between $103 at its highest and $97 at its lowest in order for the contract to go through. Anything below $104 or above $96 will cause the exchange to not honour the agreement.
How to Prevent Slippage?
Slippages can have a significant financial impact, especially for investors who frequently participate in short-term trading activities. Fortunately, there are ways to help reduce the effect of slippage on your investments.
A limit order is a type of trading order that helps minimise slippage. Slippage occurs when traders use market orders that execute at the best price. With a limit order, you can ensure that your trade is filled at precisely the price you want and not any lower.
Limit orders are helpful for investors who want to buy or sell an asset at a specific price, but they come with inherent risks. Since these orders aren’t guaranteed to execute, you may miss out on opportunities to enter into desired trades.
Trading in more stable markets can help reduce the effects of slippage on your trades. While this may seem impossible to do in the highly volatile crypto market, minimising huge losses due to slippage is still within reach. To achieve this, you should avoid trading when some significant events or announcements could potentially affect the price of cryptocurrencies. These times are when prices tend to be most volatile and could lead to extreme losses.
By investing in highly liquid assets, you can effectively mitigate the potential impact of slippages in your transactions. The ability to quickly convert these assets into cash provides you with a valuable cushion, ensuring you can navigate any unforeseen fluctuations in the market with greater ease and confidence. This liquidity enhances your financial flexibility and allows you to seize promising investment opportunities as they arise. So, consider including highly liquid assets in your portfolio to safeguard your transactions and optimise your overall investment strategy.
Slippage is an unavoidable issue in the world of cryptocurrency trading. However, with proper risk management and efficient strategies to mitigate losses, traders can make informed decisions and manage their exposure to slippages more effectively. By understanding these risks and taking precautions against them, you will be better equipped to navigate this highly volatile market.
At the end of the day, the key to successful cryptocurrency trading is to be mindful of market conditions and adjust your investments accordingly. Don’t take any unnecessary risks, and you should be able to make the most out of your trades!