Slippage is an often-heard term in financial markets and trading. It refers to any difference between what was expected for an executed trade and the actual executed price - this could occur due to market volatility, liquidity issues or delays with order execution - so understanding and managing slippage effectively are of key importance for traders as this could impact overall profits from trades.
Multiple factors contribute to slippage when trading. Market volatility often plays an influential role, particularly during periods of high uncertainty or news releases that lead to sharp price movements. Low liquidity in certain markets or trading hours may aggravate slippage further while delays due to technical or network congestion could also exacerbate it further.
Slippage can have both positive and negative ramifications for traders. While in certain instances slippage might work to your benefit, creating better entry or exit prices than anticipated, more often it causes higher execution prices for buying, or worse still lower selling execution prices, significantly decreasing profitability, particularly among short-term traders who rely heavily on precise entry/exit points for short trades.
To minimize slippage's adverse impacts, traders employ various strategies. One such way is using limit orders instead of market orders to have greater control over execution prices and potentially decrease slippage. Also incorporating stop-loss and take-profit orders may automate trade exits with reduced risk during volatile market conditions and help limit slippage risk.
Slippage can occur across markets or asset classes; stocks, forex, commodities and other financial instruments all can experience slippage at some time or another; its intensity can also differ across different assets: highly liquid assets such as stocks are usually subject to less slippage whereas less traded and illiquid markets could experience larger execution discrepancies than more traded assets.
Slippage is an inherent component of trading that can threaten its overall profitability, so understanding its causes and implications are critical in developing effective risk management strategies. By employing limit orders, stop-loss orders and selecting liquid markets they can minimize slippage's negative effects and optimize trading performance.