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Crypto trading has grown in popularity over the last few years. Many individuals are looking to gain profit and a wide interest in blockchain technology.
A better understanding of what is slippage in crypto is important, particularly as the crypto market continues to attract new traders both individuals and organizations. Whether you're a business entity or an individual trader, comprehending slippage is vital to maximizing your gains from crypto trading.
In this article, we will learn the concept of slippage in the crypto market, understand its impact on trading, and strategies to minimize its effects.
What is Slippage in Crypto
In the world of cryptocurrency trading, understanding and managing slippage is vital. Slippage in trading, by definition, refers to the difference between the expected price of a trade and the price at which it is actually executed. For instance, let's consider a slippage crypto example: you wish to buy 1 BTC at $35,000, but due to rapid market movement, the trade executes at $35,200 - that's slippage.
This is something you might experience across various platforms, including Binance, and it's important to consider how to avoid slippage in crypto to optimize your trades. One approach is to adjust your slippage tolerance, meaning the maximum price difference you're willing to accept. For example, on Coinbase Wallet, you can indirectly control slippage by setting the maximum or minimum price at which you're willing to transact, thus setting a limit order.
In terms of calculation, the slippage formula generally involves finding the difference between the expected execution price and the actual one, divided by the expected execution price, usually expressed as a percentage. By understanding slippage and using these strategies, you can better navigate the dynamic world of crypto trading.
How slippage occurs
In the table that is shown above, there are two instances in that slippage can occur. It can be on both buy or sell orders. For example, the trader places a buy order of 100 units of crypto for $10 per unit. But when the order is executed, the real price is $10.50 per unit, so there is a $0.50 per unit slippage.
In the second case, the same trader placed a sell order for 50 units of cryptocurrency at a price of $20 per unit.
The order, however, is fulfilled at a lower price of $19.50 per unit, resulting in a $0.50 per unit slippage. This table illustrates how slippage can affect both buy and sell orders.
Check out Crypto Leverage Trading: Is It Right for You?
Factors that affect slippage in crypto trading
Aside from understanding what exactly slippage in crypto is, traders must also know the factors that affect slippage. In crypto, trading slippage may be caused by a variety of factors, including market volatility, insufficient liquidity, order size, and exchange technology. Price swings and broad bid-ask spreads may emerge from high market volatility, making it more difficult to execute deals at targeted pricing.
Slippage may also occur when there aren't enough buyers or sellers to match a trader's order. Since the market may not have enough liquidity to fulfill the whole order at the given price, large order sizes might induce slippage.
Moreover, slippage may be caused by exchange technology, since delays in order execution can cause prices to fluctuate before a deal is performed.
Risks associated with slippage in cryptocurrency trading
Due to slippage, a trader can run the risk of unanticipated losses. Slippage may cause traders unexpected losses. Due to market volatility, liquidity, and other variables, transaction prices might differ greatly from predicted prices. Slippage may create unexpected and especially grave losses for leveraged or large-position traders.
Slippage and unanticipated losses might lower profitability and it may reduce total trading earnings for traders. This can occur when a sell order's price is lower or a buy order's price is higher. If a trader plans to sell a cryptocurrency for $100 per unit but only sells it at $90 owing to slippage, their earnings will decrease.
Slippage also increases trade expenses and may increase trading costs and commissions. Traders might also be forced to execute deals at higher prices, increasing costs and commissions due to slippage and frequent traders might easily lose money due to these charges.
Another factor to consider is that slippage complicates risk calculation and position management. Traders who can't gauge risk may take on too much of it which may result in losses or margin calls. Such margin calls happen when a trader does not have enough funds in their account to cover losses and the broker needs them to deposit additional cash to preserve their holdings.
Pre-trade preparation to reduce slippage
Pre-trade preparation is one of the strongest techniques to minimize slippage in cryptocurrency trading. This involves thoroughly researching market circumstances, comprehending the bid-ask spread, and establishing realistic trading objectives. By understanding market dynamics, traders are able to predict future slippage and change trading techniques appropriately.
The bid-ask spread is the difference between the highest price a buyer is prepared to pay and the lowest price a seller is ready to accept. By monitoring the spread, traders may determine the optimal time to execute transactions in order to reduce slippage.
Tips for executing trades with minimum slippage
Instead of using market orders when trading, another way is utilizing limit orders to trade with the least amount of slippage. A limit order refers to a type of order where a trader sets a pre-determined price at which they want to either buy or sell a crypto asset. A trader can set a certain price at which they want to buy or sell an asset with a limit order. Unlike in traditional fiat markets, in crypto trading, there is often no limit to limit trading which can be a great advantage if used wisely. Traders can ensure that their trades happen at the price they have set or trades don't happen at all.
A trader can control the amount of slippage when using limit orders for trading in the crypto sphere by setting prices in line with the current market rate. This prevents surprises that come from market orders like pricing discrepancies or the risk of trades being filled at unforeseeable prices. Limit orders are particularly useful during times of high volatility when prices are rapidly increasing or decreasing.
For example, the trader wishes to purchase 1 ETH at a maximum price of $1,800 per ETH. They put a limit buy order on the ETH/USD pair, indicating the maximum price they are prepared to pay and the quantity of ETH they want to purchase.
If the ETH market price falls to or below $1,800, the order will be immediately filled and the trader will pay $1,800 for 1 ETH. If the market price does not reach $1,800, the order placed will stay open until either it is filled or until the trader cancels the order. More on limit order here.
Additionally, selecting crypto exchanges and crypto assets with high liquidity can help reduce the risk of slippage.
Conclusion
In the world of cryptocurrency, slippage is a prevalent vulnerability that affects many investors, causing them to bear additional costs. While slippage occurs frequently among traders, those who possess a solid understanding of what slippage is in crypto trading gain an edge in designing and deploying trading strategies, as it can greatly impact both profitability and risk management.
Frequently Asks Questions
How much slippage should I set?
The appropriate slippage setting depends on the market's liquidity and the size of your trade. Lower liquidity and larger trades typically require higher slippage tolerance to ensure the transaction goes through. A commonly used slippage rate for highly liquid markets is around 0.5% to 1%. However, in less liquid markets, you may need to set your slippage tolerance to 2%, 5%, or even higher. It's a balance between ensuring your trade gets filled and avoiding paying a significantly higher price than you expected.
What does high slippage mean in crypto?
High slippage in crypto trading means that the execution price of a trade can significantly differ from the price at which you intended to trade. It is more common in illiquid markets or with larger trades, where the act of executing the trade impacts the market price. High slippage often means that you are paying more for a purchase or receiving less for a sale than you planned, which can negatively impact your investment return.
Is slippage bad in crypto?
Slippage itself is a natural part of trading, not only in crypto but in all markets. However, excessive slippage can be detrimental to your trading performance, as it may result in you paying more or selling for less than you initially intended. It's important to monitor and manage your slippage to ensure it doesn't significantly erode your investment returns.
What is a good slippage tolerance in crypto?
A "good" slippage tolerance in crypto largely depends on the liquidity of the market and the size of your trades. For highly liquid markets, a slippage tolerance of around 0.5% to 1% is often adequate. However, in less liquid markets or for larger trades, you may need to increase your slippage tolerance to 2% or more.
Remember, a higher slippage tolerance increases the chance your trade will be executed, but it also means you could end up paying more (or receiving less) than you intended. You should adjust your slippage tolerance based on your risk tolerance and the specific market conditions.
None of the content above is financial advice and is for educational purposes only. Find more content on algorithmic trading software, crypto market making and market microstructure on Autowhale’s blog.
