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Do you know about slippage?
It may be so small that it’s barely noticeable, but if you’re not careful, you can lose a lot of money due to slippage! ⚠️
In the cryptocurrency market, slippage refers to the price difference between the expected price of a trade and the actual execution price. The causes of slippage are diverse, including price volatility and low liquidity. If you don’t consider slippage, you might lose more money than you think🥶 Slippage is a problem that exists in both centralized exchanges (CEX) and decentralized exchanges (DEX), making it a concept you must understand when investing.
Slippage can occur in trading across all asset classes, but it’s notorious in cryptocurrencies. This is because the asset class often has high volatility and very insufficient liquidity. Let me explain each one more simply!
Traders can anticipate a specific price and place an order. However, in rapidly changing markets, the price can move significantly between the time a trader places an order and when it gets executed!
Let’s assume a trader wants to buy or sell cryptocurrency at a specific price. There may not be sufficient liquidity on the opposite side of the trade at that price. To complete the order, the trade must be executed at a price where liquidity exists. This can result in a trade being executed at a price significantly different from what the trader expected!
Slippage can be expressed as a nominal (i.e., currency) amount or as a percentage.
For example, if a trader expected to buy one Bitcoin for $20,000 but paid $20,050, the slippage is -$50. Calculated as a percentage, the trader paid (-$50/$20,000)*100 = -0.25%!
Many trading platforms, including decentralized and centralized cryptocurrency exchanges, allow traders to set how much slippage they will tolerate. In other words, market participants can prevent trades from being executed if slippage exceeds a certain ratio.
‘Slippage tolerance’ refers to the price difference between what a trader expects when placing an order and the price when the trade is executed. Generally, trading platforms display slippage tolerance as a percentage of the total trade value!
Limit orders allow investors to specify the price of their order and wait until the market reaches that price. However, limit orders also carry risks. If the market price moves further away from the investor’s specified price, the order may not be processed at all. In the case of limit sell orders, buyers take away liquidity.
After selecting custom slippage, directly specify the desired ratio. If you set the slippage limit too low, the trade may fail. You should also consider that network fees are still incurred at this time.
Using trading pairs with high trading liquidity can help mitigate slippage. New coins or less popular coins may not have sufficient liquidity needed for efficient trading. Trading popular trading pairs can reduce the impact of price changes.
The time of day you trade can also affect slippage. If possible, it’s advantageous to trade during hours when relatively fewer people are trading. Choosing the most favorable trading hours can reduce price slippage and, when using DEX, also reduce network fees.
You can minimize slippage and optimize trading by planning entry and exit prices through various tools.
Large trades have a high probability of causing significant slippage. Therefore, dividing trades into smaller units through multiple orders can be a wise strategy. For centralized exchanges, trading fees are often proportional to the trading amount, so splitting trades into smaller units doesn’t incur penalties from increased trading fees. However, all DEX swap trades incur gas fees regardless of swap size. Therefore, performing multiple orders will result in proportionally higher gas costs, so you must choose the most advantageous structure compared to potential slippage.