In an ideal world, when a daytrader place an order, the trade is executed at exactly the price specified. However, under certain conditions, the trade or operation can be executed at a different price. For example, if an intraday trader places a stop loss after having taken a long position – in other words, a trade in which he or she bought stocks instead of selling them – it is possible that the share price could fall below the price specified in the stop loss order before it can be executed. In this case, the stop order will be executed at a lower price – although the broker will try to get the best price available.
What is the cause of the slippage?
Slippage occurs in both the stock market and other markets, such as futures markets and currency markets. The main reason for this is the high volatility – as the price moves quickly in one direction or another, it is possible that there isn´t any buyer or seller at the specified price. This can be caused by strong technical factors – such as when a stock is being subjected to severe overbought – or unexpected news.
Clearly, for intraday traders, the slippage can cause significant problems with the transactions, especially when applied to stop losses – traders end up risking more on individual trades than they had anticipated, which may lead to bigger losses than expected. At the same time, it is obvious that although traders want their stop loss orders being executed, they could end up losing even more if the transaction is not executed at the next best price.
Positive and negative slippage
Positive Slippage: Positive slippage occurs when a trade is executed at a better price than the one originally intended by the trader. This is generally considered favorable for the trader because they end up getting a more advantageous entry or exit point than expected. Positive slippage often happens in fast-moving markets or during periods of high volatility. For example, if a trader places a market order to sell a stock, and the actual execution price turns out to be higher than the expected price, it results in positive slippage.
Negative Slippage: Negative slippage, on the other hand, occurs when a trade is executed at a less favorable price than the one initially specified by the trader. This is generally seen as unfavorable because the trader may experience higher losses or reduced profits due to the difference between the expected and actual execution prices. Negative slippage is more likely to occur in situations where market conditions change rapidly, and there is a delay between placing the order and its execution. For instance, if a trader intends to buy a stock at a certain price, but the execution occurs at a higher price, it results in negative slippage.
Both positive and negative slippage are inherent risks in trading, and their occurrence can be influenced by factors such as market volatility, liquidity, and the speed of order execution. Traders often implement risk management strategies to minimize the impact of slippage on their overall trading performance.
How can day traders protect themselves from slippage?
A key thing to avoid is the stock trading in which an important news is imminent. It is evident that most market news are scheduled before the market opening or after the closing of the same, so the day traders have the opportunity to avoid this type of event. However, if a press event is scheduled to occur during the trading day, then the stocks that may be affected by such an event should be avoided. This not only refers to news on the share itself – for example, if a major economic announcement in Europe in late trading day could affect an American stock during the day, is not a good idea to have an open position in this stock.
Another thing intraday traders must avoid – and this is the essence of intraday trading – is to have open positions at the end of the day. There is always a significant risk that the market gap extends higher or lower when the market opens the next time, and this can lead to large slippage – and consequently to heavy losses.
Finally, intraday traders should avoid placing market orders when they do not have to do it. A market order is an order to buy or sell at the best available price, without specifying which is the price or how quickly that trade is going to execute. Again, this can lead to a number of scenarios of slippage, and this is not necessary or desirable when a daytrader is entering the market as this could cause to buy too high or sell too low.
Tools and technologies to avoid slippage
Several tools and technologies can be employed by traders to mitigate the impact of slippage and improve their overall trading experience. Here are some examples:
Limit Orders:
- Definition: A limit order is an order to buy or sell a security at a specific price or better.
- How it helps with slippage: By using limit orders, traders can control the maximum price (for buy orders) or the minimum price (for sell orders) at which they are willing to execute a trade. This helps in avoiding unfavorable slippage.
Stop Limit Orders:
- Definition: A stop-limit order combines the features of a stop order and a limit order. It triggers a limit order when a specified price level is reached.
- How it helps with slippage: This order type allows traders to set a specific price at which the order becomes a limit order. It helps avoid the execution of the order at a significantly different price than intended.
Market Depth (Level 2) Data:
- Definition: Market depth data provides information about the order book, showing the number of buy and sell orders at different price levels.
- How it helps with slippage: Traders can analyze market depth to assess liquidity and potential slippage. This information can aid in making more informed trading decisions.
Algorithmic Trading Platforms:
- Definition: Algorithmic trading involves using computer algorithms to execute trading strategies automatically.
- How it helps with slippage: Algorithmic trading can be programmed to execute trades at optimal prices and respond quickly to market changes, helping reduce the impact of slippage.
Smart Order Routing (SOR) Systems:
- Definition: SOR systems automatically route orders to different trading venues to obtain the best possible execution.
- How it helps with slippage: SOR systems aim to find the most favorable prices across multiple exchanges, reducing the likelihood of slippage.
Fast and Reliable Internet Connection:
- How it helps with slippage: A fast and stable internet connection is crucial for timely order execution. Delays in order transmission can increase the risk of slippage.
Co-location Services:
- Definition: Co-location involves placing a trader’s servers in proximity to the exchange’s servers.
- How it helps with slippage: By reducing physical distance, co-location services minimize latency and contribute to faster order execution, helping to mitigate slippage.
Slippage Analysis Tools:
- Definition: Various trading platforms and tools offer slippage analysis features.
- How it helps with slippage: Traders can review historical slippage data to identify patterns and optimize their trading strategies accordingly.
It’s important to note that while these tools and technologies can help minimize the impact of slippage, they cannot eliminate it entirely.
