As an active crypto trader, you have undoubtedly experienced price slippage at some point. When trading a crypto asset, slippage is used to describe the difference between the expected price of the asset and its realized price. Slippage happens due to several factors and can significantly impact your trading P&L. Read on to learn about price slippage in the crypto markets and what you can do to avoid it.
What Is Price Slippage?
Price slippage in the crypto markets refers to the difference between the price you expect to pay for a crypto asset and the actual price you pay for the asset.
In other words, price slippage occurs when your trade settles for a different price than what you initially requested due to a price movement between the time your order is placed, and the execution of the transaction.
Slippage is common in crypto trading and is mostly due to the crypto asset market’s price volatility. Usually, when the market is moving swiftly, it’s common for orders to be filled for a different price versus what was initially quoted.
Price slippage can also occur when you execute a large order at a chosen price, but there isn’t enough liquidity to maintain the current bid/ask spread. For crypto traders, price slippage is more frequent on decentralized exchanges (DEXs) because they usually have less liquidity than centralized exchanges.
Slippage is classified in terms of positive or negative. Positive slippage occurs when you purchase a crypto asset for a lower price than expected. On the other hand, negative slippage happens when you buy a crypto asset for higher than your quoted price. The reverse is true for sell orders.
How to Factor Slippage Into Your Trading Plan
Price slippage typically occurs when market price volatility is high or when liquidity is low. And since traders tend to follow the market, slippage will negatively affect trading profitability when “everyone” is trying to buy or sell an asset.
Because slippage is unavoidable it is something you have to factor into your trading plan. Slippage can be added to your trading costs alongside other expenses such as fees, commissions, and spreads.
Slippage can be expressed in two ways: in a dollar amount or as a percentage. You can calculate the dollar amount by subtracting the expected price from the actual price. Having said that, most crypto trading platforms prefer to express slippage as a percentage.
To calculate the percentage of slippage, take the dollar amount of slippage and divide it by the difference between the expected price and the worst actual execution price. Then convert this into a percentage.
%Slippage = $Amount of slippage/(LP-EP) x 100
EP = expected price
LP = Limit price
How to Reduce the Potential for Price Slippage
When trading crypto assets there are several strategies you can employ to prevent slippage from cutting deeply into your trading P&L.
Arguably the simplest way to reduce slippage is to set limit orders for cryptocurrency trades instead of market orders. Market orders are almost immediately executed at whatever the current price is, thereby giving you little control over what price you receive when the order is executed.
A limit order allows you to reduce slippage by setting the maximum buying and selling limit of your crypto. Moreover, some crypto exchanges alert you when you make an order with a slippage percentage beyond a certain amount.
However, while a limit order prevents negative slippage, you still run the risk of your trade not being executed as long as the price does reach your price limit to execute.
Additionally, you can set your slippage tolerance (how much price slippage you will allow) to low when trading on decentralized exchanges that operate on an automated market maker (AMM) protocol. That way, you can reduce the impact of slippage.
However, having a low slippage tolerance may mean your transaction is never executed and locks you out of profit from significant price movements. On the other hand, if you set your slippage tolerance too high you may become susceptible to frontrunning.
Finally, do your best to trade crypto in highly liquid markets to reduce slippage. Liquid markets increase the chances of your order being executed at the quoted price. Also, you should avoid trading large volumes during periods of low liquidity like overnight or during weekends if you want to reduce the chance of slippage affecting your trading profitability.
What is Price Slippage in the Crypto Markets?
Price slippage refers to the difference between the quoted price and the actual price at which you will buy or sell a crypto asset. The higher the price slippage, the more it will affect the profitability of your trade.
How Can I Reduce Slippage When Trading on a DEX?
If you are trading on decentralized asset swapping protocols, arguably the easiest way to reduce the negative effects of price slippage is to set your slippage tolerance to low. Most leading decentralized trading venues provide this feature.
How Can I Reduce Slippage When Trading on a CEX?
Arguably the easiest method you can use to reduce the impact of price slippage on centralized crypto exchanges is to use limit orders instead of market orders and stick to trading in liquid markets.