Slippage occurs when the actual execution price differs from the expected price of an order. Therefore, the execution price of an order is different from the price at which it was sent. This most often happens with market orders during periods of high volatility, but slippage can also occur on large orders and stop orders.
The term “slip” tends to carry an unfortunate negative connotation. However, slippage is not always unfavorable to the trader, rather there is only a difference in the expected execution price.
Before exploring the intricacies of slippage, it is important to understand the following fundamental components of trading:
- There must be a buyer and a seller for a trade to take place. If one tries to sell a crude oil futures contract at 50 . 10 , a counterparty must be willing to buy at 50 . 10 otherwise the order will be executed at the next available price.
- By using market orders and market stops, the intention of the trader is to close as soon as possible, regardless of the price. Submitting a market order is essentially saying, “I want to be executed immediately at the best available price.”
3 types of sliding
With the above concepts in mind, here are 3 types of slippage that can occur. Crude oil futures contracts are used as an example:
Fluctuation in buy/sell prices
A market buy order is submitted when the lowest bid is 50 . ten . A fraction of a second before the order hits the market, the lowest bid becomes 50 . 12 due to increased purchases. In this case, the command is executed in 50 . 12 with a slip of 2 ticks. The wait was 50.10, but the fill price was 50. 12 . Since the trader chose to submit a market buy order, to be executed as soon as possible, a slight slippage occurred.
A market sell order is submitted to sell 20 contracts at 50 . ten . On the supply side, there are two offers for a total of 20 contracts. The first offer concerns 13 contracts at 50 . 10 and the second is 7 contracts at 50 . 09 . Under the trade matching rules, the request for all 13 contracts will be completed without slippage. However, there will be 1 slip tick in 7 contracts at 50 . 09 .
This can happen when a market order is submitted and the best available price suddenly falls below the asking price during transit. A market buy order sent at 50 . 10 fills 50 . 08 would cause a positive slippage of 2 ticks.
Slippage due to high volatility
During times of extreme volatility, the following order types may experience some slippage.
When the market is rising sharply, slippage can occur when the order is triggered before it can be executed, because the market price exceeds the stop price.
Stop Limit Orders
It is possible for the market to move far enough and fast enough that a stop is not filled. If this happens, the order becomes a limit order at the highest or lowest price set by the user.
Instances of large market fluctuations are rare, however, extremely volatile conditions have occurred around news events. Traders should be aware of potential volatility and use appropriate risk mitigation measures.