By Minal Thukral
When it comes to trading in financial markets like stocks, bonds, or crypto, there’s a term that traders frequently encounter: slippage. But what does slippage actually mean? Well, it’s quite simple. Slippage refers to the difference between the price you expect to pay for a trade and the actual price at which the trade is executed. In this article, we delve into the realm of slippage within the context of crypto trading, unearthing its intricate mechanics and its underlying causes, and evaluating its potential impact on trades.
Why does slippage happen?
This disparity usually arises during periods of high market volatility or when liquidity is low. Slippage can work in favor of or against traders, resulting in either profits or losses. Even seasoned traders can experience slippage. Therefore, it is crucial to grasp the concept of slippage and learn how to minimize its impact.
How does slippage work in crypto?
Slippage in the crypto market is primarily driven by market volatility and liquidity. Although these factors may seem straightforward, their intricate interplay within the fast-paced world of crypto can significantly impact trade outcomes.
To better understand slippage, let’s consider an example of volatility-induced slippage. Suppose you place a market order to buy Ether at $1800. However, due to rapid price fluctuations, your order gets executed at $1830. In this case, you have experienced negative slippage of $30.
Another factor contributing to slippage is low liquidity. In highly liquid markets, there are enough buyers and sellers to absorb large orders without significantly affecting the price. However, in less liquid markets, a substantial order can cause significant price shifts. For instance, imagine you intend to buy a large volume of an altcoin on an exchange with low liquidity. If there are insufficient sell orders at your desired price, the trade may execute at a higher price, resulting in negative slippage.
Minimizing slippage in crypto trading
Understanding slippage and the factors influencing it is the first step in reducing its impact on your crypto trades. Here are some strategies to help mitigate slippage:
Use Limit Orders: Unlike market orders, limit orders are executed at a specific price point, ensuring that you don’t pay more or receive less than your specified price. This protects you from unexpected price changes.
Trade During High Liquidity Periods: Slippage primarily occurs due to low liquidity and high volatility. You can avoid these conditions by trading during periods of high liquidity and low volatility.
Select a Reliable Exchange: Opt for exchanges known for high liquidity and lower slippage rates. Exchanges with a larger number of participants tend to offer better liquidity, resulting in more efficient order execution.
Adjust Your Slippage Tolerance: Some trading platforms allow users to set their slippage tolerance levels. By determining a maximum acceptable price difference for your trade, you can limit the potential negative impact of slippage.
Break your large orders into small ones: When dealing with large orders, it is often advisable to break them into smaller ones to mitigate the risk of high slippage. When placing a large order, the sheer volume of crypto or tokens being bought or sold can influence the market, causing the price to move unfavorably. By breaking the order into smaller parts, market impact can be reduced, and the risk of significant price deviation can be minimized. This strategy allows for a more controlled execution, potentially achieving better overall trade outcomes while avoiding substantial slippage costs.
Pay higher gas, trader on L2 based DEXes: To minimize slippage on Decentralized Exchanges (DEXes), consider paying higher gas fees to prioritize transactions, trading on Layer 2 DEXes for faster and cheaper transactions, monitoring liquidity to select exchanges with deep pools, utilizing limit orders for precise execution, and trading during periods of lower volatility to avoid sudden price fluctuations that can lead to slippage.Remember, while slippage is common in volatile markets like crypto, it is not always a negative occurrence. With the right strategies and tools, you can effectively manage slippage and even turn it to your advantage.
The author is Head, Growth and Strategy, CoinDCX
