What Is Slippage And Why It Matters In Stock Trading?

Slippage is the disparity between the anticipated price of a trade and the price at which the trade is actually done. This price discrepancy happens in every market location, such as equities, bonds, currencies and futures. For traders like you, a thorough understanding of slippage is important as it affects trading costs and potential profits directly.

Understanding Slippage In The Stock Market

Slippage occurs when you put in an order to purchase or sell a stock at a given price, but the order is executed at another price. Assume that you need to purchase ABC company shares at Rs. 2,500 per share but your order is executed at Rs. 2,550. This means that you have incurred a slippage of Rs. 50 per share.

Slippage occurs in the stock market, particularly under conditions of high volatility or during the trading of less liquid shares. Rapid price movements on the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) may result in execution prices being different from expected prices.

Types Of Slippage

Positive Slippage
This occurs when the price moves in your favour. For instance, if you place a buy order for ABC Motors at Rs. 400, but the order is filled at Rs. 395, you've received a better price than expected. This improves your profit potential when you sell.

Negative Slippage
This happens when the price moves against you. If you place a buy order for ABC Bank at Rs. 400, but your order is filled at Rs. 405, you have experienced negative slippage of Rs. 5 per share. This means you paid more than anticipated, reducing your potential profit.

Why Does Slippage Happen?

• Market volatility
  

Slippage is more common during times of great market volatility. When prices fluctuate quickly, the interval between ordering and order execution can witness considerable price changes. Significant economic announcements or news about a particular company can lead to short-term volatility, heightening the probability of slippage.

• Order size
  

Larger trade orders may experience more slippage, especially in markets with limited liquidity. When you place a large order, it may need to be filled at multiple price levels, causing the average execution price to differ from the expected price.

• Market liquidity
  

Low liquidity in certain stocks increases the risk of slippage. This is more applicable to Indian mid-cap and small-cap stocks, as these tend to have lower volumes than large-cap stocks.

• Market hours
  

The timing of your trades matters. More volatility and therefore more slippage can occur at market opening and closing times on the Indian exchanges.

• Latency issues
  

The time it takes for your order to reach the market and be executed can lead to slippage. This delay, known as latency, gives time for prices to fluctuate prior to your order being executed. Low internet speeds or old devices can cause higher latency and subsequently slippage.

How Slippage Affects Traders

• Impact on trading costs
  

Slippage in trading can cause unexpected costs for traders, reducing their overall trading performance and returns. For day traders and scalpers who make frequent trades with small profit margins, even minor slippage can significantly impact profitability.

• Effect on stop-loss orders
  

Slippage can cause stop-loss orders to be activated at different levels than expected, potentially increasing losses. This is particularly problematic during fast-moving markets or gap openings.

• Loss of potential earnings
  

Traders may lose potential earnings due to slippage if the market moves in their favour, but the trade is executed at a less favourable price.

Strategies To Minimise Slippage In Markets

• Use limit orders
  

Limit orders let you set the price at which you would want your order executed. Unlike market orders, which execute at the best available price, a limit order can only execute on your defined price or better, thus eliminating negative slippage. However, it carries the risk that your order may not be executed if the market price doesn't reach your limit.

For example, if you want to buy a stock at Rs. 700, you can set a limit buy order at that price. The order will only be executed when the market price reaches Rs. 700 or lower.

• Avoid volatile market conditions
  

Timing your trades to avoid periods of high volatility can help reduce slippage. This includes avoiding trading during major economic announcements, company results, or other significant news events that could cause rapid price movements.

• Trade liquid securities
  Trading stocks with high liquidity can reduce slippage. Large-cap stocks like those in the Nifty 50 or Sensex typically have higher liquidity and lower slippage compared to mid-cap or small-cap stocks.

• Implement algorithmic trading
  

For larger orders, consider using algorithmic trading strategies that break down big orders into smaller, more manageable pieces and execute them over time. This approach reduces the market impact of large trades and helps mitigate slippage. There are various platforms that offer algorithmic trading capabilities for traders.

• Use stop-loss orders
  

While stop-loss orders themselves can be subject to slippage, they help limit potential losses by automatically closing positions when prices move against you. This prevents further losses if the market continues to move unfavourably.

Conclusion

Slippage is an unavoidable aspect of trading in stocks, especially in volatile markets like India. Knowing what leads to slippage and applying measures to reduce its effect can help traders like you in safeguarding their profits and cutting unnecessary expenses. Remember that your trading strategy should be flexible, allowing you to adapt to changing market conditions and consistently minimise slippage. With proper planning and risk management, slippage can be controlled, if not eliminated, from your trading experience.