What Is Slippage in Crypto Trading How to Avoid It?

If you trade cryptocurrencies or stocks, you might have encountered a term called slippage at some point in your journey. Slippage is common in various asset markets, and cryptocurrencies are no exception. It is important for crypto traders to know what slippage means and how it impacts their trades. In this article, we will take a deeper dive into the concept of slippage and offer tips on minimizing its effects. Let’s take a look:

What Is Slippage?

Slippage in crypto trading is an important concept that can greatly influence your transactions. Essentially, it’s the difference between the price you expect to trade a cryptocurrency at and the price at which the trade is actually executed. This difference can occur due to multiple factors, such as market volatility, liquidity issues, and order size.

For example, let’s say you place an order to buy Ethereum at $3,000. However, by the time your order is processed, the price has risen to $3,010. In this scenario, you’ve experienced slippage of $10.

Slippage is more relevant in fast markets like cryptocurrency, where the volatility is quite high. It’s crucial for traders to be aware of slippage and take measures to minimize its impact on their trades. We’ll explore strategies for avoiding high slippage in the next section.

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Positive and Negative Slippage Explained

Slippage can affect your trade positively or negatively. Here’s what it means for your trades:

Positive Slippage

Positive slippage occurs when an order is filled at a better price than expected. For example, if you place a buy order and it gets executed at a lower price than you requested, you’ve experienced positive slippage. This can lead to better buying rates and increased profit opportunities for traders. As it is apparent, you are not losing anything in this scenario but, in fact, gaining something.

Positive Slippage Example: Let’s say you’re interested in buying XRP at $0.40 per token. You place your order and are pleasantly surprised when it gets filled because you just snagged it for $0.39 instead. This is a case of positive slippage, or no slippage, where your order is executed at a better price than anticipated. It’s a fortunate turn of events that gives you a chance to boost your profits a little bit.

Negative Slippage

Negative slippage occurs when an order is filled at a worse price than expected, usually because of sudden market changes. This can result in unexpected losses or lower profits for traders. It’s crucial to be aware of negative slippage as it can have a significant impact on your trading outcomes.

Negative Slippage Example: Let’s say you want to buy XRP at $0.40 per token. You see the price moving in that direction and quickly place a buy order. However, when your order is filled, you realize it’s at $0.41 instead of your target price. This is a case of negative slippage, where sudden market changes lead to your execution price being worse than expected.

What Causes Slippage?

Limited Market Liquidity

Certain cryptocurrencies have limited popularity, which is why they have limited liquidity. This scarcity of liquidity makes these tokens more susceptible to slippage. With fewer buyers and sellers available, placing an order can cause big price changes as the system matches orders with available counterparties. The bigger the order, the more likely you are to experience high slippage in this scenario.

In a more liquid market, the chances of significant price slippage decrease. For instance, if you aim to buy two tokens of a cryptocurrency priced at $200 each, but the best order available is only for one token, the system searches for the next available level to fulfil the order. This can result in price escalation. When this happens, you end up paying more than the intended execution point, making the best available market price less favorable.

Volatility

If there is one thing cryptocurrencies are known for, it’s their volatility. The constant fluctuations in price expose trade orders to slippage risk. Market factors such as supply and demand, investor sentiment, user interest, and regulatory changes can quickly influence cryptocurrency prices. These variables and the market’s relative newness create an environment where prices can seesaw dramatically between order placement and execution.

Check out: How to Recover Crypto Sent to A Wrong Network or Address

Slippage Tolerance

Slippage tolerance serves as an important tool to protect trades from volatility. By setting a slippage tolerance percentage, traders can anticipate and manage the fluctuations better. This allows them to specify their acceptance of price changes within a certain range, whether the changes are upward or downward.

Low Slippage Tolerance

Opting for a low slippage tolerance means sticking to strict price boundaries. For example, if a trader selects a 4% slippage tolerance and intends to invest $1000 in a cryptocurrency, the trade will only proceed if the price remains within a maximum of $1040 or a minimum of $960. Beyond these limits, the trade won’t execute. It is an excellent way of exposing yourself to slippage without risking too much.

High Slippage Tolerance

On the other hand, a high slippage tolerance offers flexibility during major price fluctuations. This approach is particularly useful in volatile markets or with crypto projects characterized by lower liquidity but significant trade volume. Despite big price shifts, transactions are executed within the predefined slippage tolerance range.

If you are opting for this, it is important to keep in mind that you are exposing yourself to greater risk. Front running also includes exploiting advanced information to capitalize on securities trading. An attacker may strategically place larger transactions before and after a pending trade, forcing the trader to accept a higher slippage price within the preset tolerance.

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Tips for Avoiding Slippage

When trading on any kind of cryptocurrency exchange, traders can use different tactics to minimize slippage-related losses:

Use Limit Orders

Using limited orders is a great way of avoiding slippage. Instead of executing trades at market prices, consider using limit orders so you can execute the trade at a specified amount. While limit orders may risk non-execution, they take the possibility of slippage completely out of the picture.

Divide Large Transactions

For traders dealing with substantial volumes of cryptocurrency, breaking large transactions into smaller portions can help mitigate market impact and potential slippage-induced losses. This strategy reduces the likelihood of significantly moving the market with a single substantial trade.

Trade During Low Volatility Periods

Avoid trading during high volatility windows, such as the European-to-U.S. crossover or peak U.S. market hours. Also, stay away from major market events, such as CPI or other economic data releases or central bank announcements. Staying clear of these events can protect you against volatility and slippage.

Adjust Gas Fees

Blockchain networks like Ethereum accelerate transaction processing by opting to pay a higher gas fee. This prioritizes your transaction in the validation queue and reduces the risk of slippage. Utilize tools like Etherscan to find out about the ideal gas fees for effective transaction prioritization.

Layer 2 Solutions

Consider opting for layer-2 scaling solutions like Polygon for decentralized exchanges (DEXs). Layer-2 networks offer faster transaction processing, reducing slippage risks and gas fees compared to layer-1 networks during periods of congestion. You are more likely to have a better experience with a layer-2 solution compared to layer-1 networks like Ethereum.

Use Slippage Tolerance

Many DEX platforms allow traders to manage their slippage tolerance. While a lower tolerance may take more time to execute, it will protect you against some significant losses that can occur due to price slippage.

Final Takeaway

In conclusion, slippage is a very common thing in crypto trading and is mainly influenced by factors like volatility and liquidity. It can either be positive, providing better prices than expected, or negative, which can lead to unexpected losses. While no investor minds experiencing positive slippage, minimizing unplanned negative slippage is not easy. To avoid slippage, you have to come up with better strategies and always keep an eye on the cryptocurrency’s liquidity and volatility.

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