Slippage

Definition:

Slippage is a phenomenon in which a financial asset’s price moves in the opposite direction to the direction in which it is being traded. It occurs when there is a sudden shift in market sentiment, causing the asset’s price to deviate from its previous trend.

Causes:

• High volatility: Assets with high volatility are more prone to slippage, as their prices fluctuate wildly in response to changes in market conditions.
• Order imbalances: When a large number of orders are placed in the opposite direction of the prevailing trend, it can cause slippage.
• Market microstructure: The design of the market infrastructure, such as the presence of limit orders or dark pools, can influence slippage.
• News and events: Breaking news or events can cause a sudden shift in market sentiment, leading to slippage.

Examples:

• A stock is rising in price, but a large sell order is placed, causing the price to drop.
• A currency pair is appreciating, but a large sell order for the pair is placed, causing the price to depreciate.

Impact:

• Loss of potential profits: Slippage can result in missed profit opportunities if the asset moves in the opposite direction to your trade.
• Increased transaction costs: Slippage can increase the cost of trading, as it can lead to more frequent trades and transaction fees.
• Swings in market direction: Slippage can cause sudden changes in market direction, which can impact the overall market and your investments.

Mitigation:

• Use stop-loss orders: Stop-loss orders can help limit potential losses due to slippage.
• Place limit orders: Limit orders allow you to specify the maximum price you are willing to pay for an asset, which can help reduce slippage.
• Trade with a lower time frame: Trading on a lower time frame, such as a day chart, can reduce the impact of slippage.
• Manage your risk tolerance: Understand your risk tolerance and the potential for slippage before trading.