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Slippage

Definition

Slippage is a financial term that refers to the difference between the expected price of a trade and the price at which it is actually executed. It often occurs in periods of high volatility when market orders are used, and also when large orders are executed when the market lacks enough immediate liquidity. Slippage can result in either a less favorable price or a more advantageous price than originally intended.

Phonetic

The phonetic spelling of “slippage” is /ˈslɪpɪdʒ/.

Key Takeaways

<ol> <li>Slippage refers to the difference between the expected price of a trade and the price at which the trade is executed. It is a term used in both forex and stock trading, and it often occurs during periods of high volatility when market orders are used, affecting the trade results negatively or positively.</li> <li>There are three types of slippage: positive, negative, and no slippage. Positive slippage is when execution price is better than the expected price, which is an advantage to the trader. Negative slippage is when execution price is worse than the expected price, bringing about losses. No slippage means the trader bought or sold exactly at the expected price.</li> <li>Slippage is not always a bad thing as it is a natural part of trading. However, it can be reduced. To control or limit slippage, traders can employ strategies such as ‘stop-limit’ orders, setting ‘maximum deviation’ , avoiding trading during volatile market periods, and trading with a broker who offers price improvement technologies.</li></ol>

Importance

Slippage is a critical term in the context of business and finance as it represents the difference between the expected price of a financial transaction and the actual executed price. This term is particularly relevant in trading, where the speed of execution can significantly impact the profitability of transactions. It’s usually caused by market volatility and swift price movements. However, slippage also can occur due to lower market liquidity. Hence, slippage is a key indicator of the efficiency and effectiveness of a trading strategy or system and understanding it helps investors and traders manage potential risks and costs associated with their transactions.

Explanation

Slippage refers to the difference between the expected price of a trade and the price at which the trade is executed. In finance, it serves the purpose of detecting the variance that can occur when executing an order, especially large volume orders. It is a crucial consideration to traders and investors as it can significantly affect the profitability of their trades. Slippage can occur as a result of several factors, including price volatility, market liquidity, and high-speed trading.In term of its usage, slippage primarily acts as an indicator of the liquidity and volatility of the market, facilitating more accurate investment decisions. For example, a trader might use slippage to evaluate the efficiency of a trading algorithm: a larger than expected slippage might indicate that the algorithm is executing trades at unfavorable prices. Developers of such algorithms, meanwhile, strive to minimize slippage to maximize their trade’s effectiveness. In this way, slippage serves as a measure of market dynamics and helps in refining trading strategies.

Examples

1. Foreign Exchange Trading: Slippage often occurs in forex trading, where changes in market prices can occur within the blink of an eye. For example, a trader may place a market order to buy USD for a specific rate of 0.80. However, due to volatility in currency exchange rates, the order could be executed at, let’s say, 0.81, which is an unfavorable condition for the trader. The difference or loss from the expected and real execution price is the slippage.2. Stock Market Trading: An investor wants to buy 1,000 shares in a company at the market price of $10 per share. However, by the time the order is placed and executed, the market price for the stock has risen to $10.10. Therefore, the investor ends up paying an extra $100 for the shares. This discrepancy between the price at which the investor expected to buy and the actual price paid is an example of slippage.3. Commodity Trading: If a commodities trader places an order to buy several barrels of oil at a certain price, but due to sudden changes in the market (such as news about an oil shortage), the price increases before the order is fulfilled, this results in slippage. The trader ends up paying more than originally anticipated because of the speed at which the order was executed.

Frequently Asked Questions(FAQ)

What is Slippage in finance?

Slippage is a term used in finance to refer to the difference between the expected price of a trade and the price at which the trade is executed. It generally occurs during periods of higher volatility when market orders are used, and also when large orders are executed when there may not be enough interest at the desired price level to maintain the expected price of trade.

What causes Slippage?

Slippage is usually caused by changes in supply and demand in the market. For example, if a large number of orders are placed on one side of the market, and not enough on the other side to balance it out, it can cause the price to move and create slippage.

Is slippage always negative?

No, slippage can either be positive or negative. Negative slippage is when the price moves against you, while positive slippage is when the price moves in your favor. However, slippage is often seen as a negative occurrence due to the unexpected cost it can add to a trade.

How can traders minimize the effect of slippage?

Traders can minimize the effects of slippage by considering the use of limit orders instead of market orders. Additionally, traders can also avoid trading during volatile periods to further reduce the likelihood of experiencing slippage.

What is the difference between Slippage and Skid?

Skid is essentially another form of slippage, but more specifically it’s the consequential change between the executed price and the intended execution price, which can be caused by commission expenses, taxes, or changes in the underlying asset’s price.

Does slippage occur in all financial markets?

Slippage is a common occurrence in all financial markets including Forex, commodities, equities and bonds. It is mainly influenced by factors such as market volatility and liquidity.

How does slippage affect the outcome of a trade?

Slippage impacts the outcome of a trade by changing the entry price of a trade. This, in turn, affects the potential profit/loss of the trade. If a trade has negative slippage, the cost of the trade will go up, thereby reducing the potential profit or increasing the potential loss.

Related Finance Terms

  • Market Liquidity: This refers to how rapidly an asset or security can be bought or sold in the market without affecting its price. Lower market liquidity often leads to higher slippage.
  • Order Execution: This term refers to the process by which a broker carries out an investor’s trading order. Slippage can occur during this process if the order execution isn’t immediate.
  • Limit Order: It is an order to buy or sell a security at a specific or better price. A limit order can help to prevent slippage as it sets an exact price for transactions.
  • Market Order: An instruction given by an investor to buy or sell a security at the best available price. Market orders are more prone to slippage as they’re dependent on market fluctuations.
  • Direct Market Access (DMA): This is a term for when brokers offer their clients direct access to the exchange systems. DMA can potentially lead to lower slippage due to increased order execution speed.

Sources for More Information

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