Disclaimer: This is for informational purposes and is not meant to serve as financial or investing advice.
What Is Slippage in Crypto?
Slippage is the difference between the price at which a market order is placed and its execution price. Slippage can occur when the market price changes dramatically after an order is placed and before it is executed.
Positive slippage means an order was filled at a higher price than where you placed the order. Negative slippage is when the order fills at a lower price than intended. If you’re buying, slippage could benefit you by giving you a slightly better price.
It’s always frustrating to see the actual price of a trade be different than intended. The good news is slippage can be anticipated and mitigated by careful traders.
What Is Slippage Tolerance?
Slippage tolerance is the amount of slippage a trader deems acceptable in a given trade. Most decentralized exchanges have a slippage tolerance input.
Before you make a trade, you input your max slippage limit. If a trade is executed above the max slippage, the transaction and, therefore, the order cannot be placed.
On centralized trading platforms like Coinbase or Binance, slippage can occur when you place a market order.
Why Does Slippage Happen?
Markets Are Young
Nascent cryptocurrency markets are ripe for exploitation. A combination of low liquidity, high volume, and volatility is the perfect storm for causing slippage.
There’s a reason why slippage as high as 20% is common on Uniswap but unheard of trading the NASDAQ. One market is mature and has trillions more in volume regulating price.
Leveraging
Leverage is a popular tool for cryptocurrency traders to increase their profits. However, the abuse of this tool can lead to increased volatility in crypto markets and, therefore, slippage.
When a trader gets their leverage position liquidated, it clears their other orders. As a result, order books can quickly get cleared out and result in a cascading price.
It can be almost impossible to avoid slippage in conditions like this.
If you’re interested in leverage, you can learn more in our guide to leverage for beginners.
Slow Transaction Speed and High Volatility
The transactions aren't always instantaneous when you place an order on a blockchain-based decentralized exchange. Of course, this depends on the blockchain. Some chains have trading dApps that execute orders instantly.
When volatility is high and you are waiting on the blockchain to process a trade order, there will be a lot of slippage. As a result, many beginner traders set their slippage high.
This is a bad idea because brilliant coders write bots that look for high-slippage orders in the blockchain meme pool and front-run them to make a profit.
By setting your slippage limit, you are placing a public order saying you will pay above the market price for an asset. Every beginner DEX (decentralized exchange) trader has fallen victim to a slippage bot.
Liquidity Issues
Price swings dramatically when the liquidity of a token is low. Many altcoins have low liquidity on crypto exchanges, making the expected try swing significantly when large buy orders roll in.
How Can You Avoid Slippage in Crypto?
1. Set Limit Orders
Limit orders only execute if the price reaches a predetermined level. Then if there is a counterparty, your order is filled at that price level.
Crypto traders can use limit orders to avoid slippage by choosing levels to buy or sell. Even if you want to buy or sell at the market price, you can still use limit orders as a safeguard.
Limit orders can help you always get the best price. When buying, you can set a limit order just below the market price; position it just above the market price when selling.
2. Trade When Volatility Is Low
Low volatility periods can be excellent for entering or exiting positions. Usually, there’s low volatility when there’s low trade volume.
It’s imperative to avoid volatility when trading low-liquidity altcoins. Low liquidity causes price action to change when large buy orders come in drastically.
3. Utilize Stop-Loss Orders
Stop-loss orders are different from limit orders. Stop-loss orders are meant to minimize your downside losses.
Stop-losses are triggered at a predetermined level and then executed at market price. This differs from limit orders because they are executed only at a limit price.
Stop-losses are great because they will always be filled. Limit orders might not necessarily be filled if the price moves quickly past your limit price.
However, the drawback to stop-loss orders is that if there’s a flash crash, your order could execute much lower than your stop-loss level. You can use limit orders in conjunction with stop-losses to reduce this risk.
4. Understand Entry and Exit Points
Understanding a trade's entry and exit prices can help you avoid slippage by only setting trades at prices that are likely to be filled. Simply put, if you place orders at the wrong prices, they won’t be filled.
If your orders aren’t filled, you may be forced to buy or settle for prices that aren’t ideal. Both add to your risk of slippage.
Plan your trade’s entry and exit points before you carry it out. Using a combination of limit and stop-loss orders, you can avoid slippage entirely if you have a good plan.
If you’re still worried about slippage, Pluto can help you protect your portfolio with Pluto Shields.
What Are Examples of Slippage?
There are many scenarios where you might experience slippage. Sometimes slippage happens due to ordinary, everyday volatility.
Slippage can be event-driven. If you are trying to place orders while the market reacts to the news, that’s a recipe for slippage.
For example, if a government announces new regulations against crypto, Ethereum (ETH) prices will respond by decreasing sharply. This first decrease comes from sharp traders who are always ready to sell quickly.
Others may see the news and this steep decline and pile in to sell. Add in those trying to capitalize off the panic by buying lower, and you’ve got extreme volatility. If you’re trying to trade this event, you’ll likely experience slippage.
Slippage can also occur when a more sophisticated trader takes advantage of your order. Say you place a market order for 10 tokens for $10.
A bot sees your order being placed and buys the token before you, then sells it back to you at $11 a token. This is called a front-running bot. These kinds of bots run rampant on decentralized exchanges (DEXs).
Some high-frequency traders with access to order book data can front-run to a degree. But they can’t ensure those front runs as blockchain-based bots can. That’s why most DEXs offer slippage limits. If the price changes too much after you’ve placed an order, the transaction will automatically be canceled.
How Can You Calculate Slippage?
You can calculate slippage with this formula. Slippage = (fill price-expected price)/expected price
You can multiply the whole thing by 100 to get slippage in percentage form.
Let’s say you want to buy Bitcoin for $10,000. After you place the order, it fills at $110,000. If we plug that into the slippage formula, it looks like this:
(110,000-100,000)/100,000 = .1
In this case, we experienced a slippage of 10%. That is high slippage. Usually, traders seek to limit their slippage to less than two or three percent. Depending on your strategy, slippage can eat into your profits. So it’s crucial to calculate slippage in your head quickly.
The Bottom Line
If you’re trading cryptocurrency, you’re going to encounter slippage. Even if you’re a beginner trader, understanding slippage gives you one more tool to beat the market.
Thousands of traders are waiting to exploit inefficiencies in the market by capitalizing on slippage. To combat this, you need to plan your entries and exits carefully. Then you can use limit orders and stop-loss orders to ensure you get the best market prices.
You can capitalize on volatility by using Pluto’s automated crypto trading strategies. Try them out today.
Sources:
The Basics of Trading a Stock: Know Your Orders
