What is Slippage?

A universal fact is that financial markets and uncertainty go hand-in-hand. Price movements tend to fluctuate continuously and have an impact on trading. Many investors have experienced such market volatility and either benefitted from it or faced repercussions. Slippage is one such by-product of volatility and uncertainty.

What is Slippage in Stock Market?

Slippage is the difference between the actual and expected trade price of an order. This phenomenon occurs not only in the stock market but also in the Forex and Futures market. Slippage in the stock market refers to the difference between the price at which an order is placed versus that of an executed order. To simplify, slippage occurs when the trade is executed at a price other than the one that is requested.

At first, it seems as though slippage is an error while trading. However, it is quite the contrary. Slippage tends to occur in the following scenarios:

• Fast-moving or volatile markets:

  Primarily, slippage occurs when markets are highly volatile. In a fast-moving or volatile market, the prices of securities fluctuate at a rapid rate. At times, it may not be possible to request a trade at a specific price and execute it at the same price. Price movement occurs rapidly in a volatile market in such a way that the price changes within the time it takes to place an order. Eventually, the order is executed at a price other than what is requested.

• Low Liquidity:

  Slippage is inevitable in a low liquidity market considering the number of participants is relatively lower. Finding a buyer who is willing to purchase securities at the price requested may be challenging. Similarly, finding a seller to sell securities at the desired price is also tough. Hence, the time gap between placing the order and the execution of the order is considerably wide. As a result, the trade may not get executed at the price at which the order is placed.

  Slippage may also occur when a huge market order is placed but there is the insufficient volume at the price on which the trade is requested to maintain the bid-ask spread.

• Major Announcements:

  With every major announcement, there is an impact on individual security as well as the market. For example, interest rate announcements by the Central Bank, regulatory changes, etc. Some announcements or events are company-specific such as a change in management, the release of a report on the financial performance, etc. These events momentarily increase volatility and eventually the probability of investors experiencing slippage.

  Similarly, holding positions after market hours also increases the chance of slippage. The reason is price may fluctuate as a result of any news, events, or announcement which happens after market hours.

To further understand the meaning of slippage, let’s discuss the impact it bears on an investor’s position. Slippage may be positive, negative, or neutral. The impact of slippage is a factor of the type of order (buy or sell), whether it is for an opening or closing position, and the price movement. Slippage can be categorized as positive if the investor benefits from it and negative if the investor detriments from it. Slippage is neutral when it has no impact on the position.

For example, if a purchase order is executed at a price lower than the order price, it is favorable to the investor and is referred to as positive slippage. Whereas, if a sell order is executed at a price lower than the order price, the investor is at a disadvantage and so it is a negative slippage.

Having defined slippage, where can slippage be mitigated or avoided? The following methods may be employed:

• Trading in low volatility and high liquidity markets The prices in a low volatility market tend to fluctuate slightly. Hence, the difference between the order and trade price is restricted to a bare minimum. Similarly, in high liquidity markets, buyers and sellers are trading on the other side of the order price. Hence, the risk from slippage can be mitigated in such a case.
• Placing limit orders guarantees the execution of the trade at the price specified. On placing a limit order, the trade is executed either at the price requested or a favorable price. Hence, it is possible to eliminate the risk of slippage.

How does slippage work?

A market order is an order to buy or sell a security at the current market price. This price is also the best available price in the market at a particular time. The market price is dynamic and dependent on various factors. A market order typically guarantees execution, but it does not ensure a specified price. Market prices change frequently, allowing slippage to occur during the time between placing an order and its execution.

While a limit order prevents negative slippage, it carries the risk of the trade not being executed at all. Whereas a market order ensures execution of the trade without any guarantee concerning the price at which it gets executed.

Example of slippage

Suppose, a buy order is placed for 50 shares of ABC Corp. The market price at the time of placement was Rs. 120 per share. However, the price at the time of execution is Rs. 140 per share. Thus, in this case, the slippage is Rs. 20 per share. On an aggregate basis, the slippage is Rs. 1000 i.e., the purchase cost increases by Rs. 1000. An increase in purchase costs is unfavorable to the investors. In this case, slippage means negative slippage.

Conversely, if the execution price is Rs. 110 then it is a positive slippage to the extent of Rs. 10 per share. The investor saves Rs. 500 from slippage.