In day trading, slippage is one of your most significant risks. It can occur when you are trying to enter or exit a trade, and it can cause you to lose money that you shouldn’t have lost. This post will discuss slippage, how it can affect your trades, and how to avoid it.
Slippage
Within financial markets, when you place a market order to buy or sell a stock, you expect it to fill at the quoted bid-ask price. However, this is not always the case due to the nature of the market.
Slippage typically occurs during high-volume periods, when there is a significant imbalance between buy and sell orders. For example, if a trader is trying to buy a certain number of shares of a stock, but the stock is only available for sale at a much higher price, this would lead to slippage. Similarly, if there is a lot of selling pressure for a particular stock, the price may decline rapidly, leading to slippage for anyone trying to sell at that time.
Slippage can also occur due to changes in market conditions, such as when a major news event causes a sudden shift in investor sentiment. In these cases, it may be difficult to execute trades at prices quoted just moments before.
While negative slippage is often considered “negative,” it can provide opportunities for savvy traders. For example, if a stock is falling rapidly and there is high selling pressure, a trader might be able to buy the stock at a lower price than what was quoted earlier. Similarly, if a stock is rising quickly and there is high buyer demand, a trader might be able to sell the stock at a higher price than what was quoted earlier.
The key to making money from slippage is to be aware of it and to trade accordingly. By understanding how and when slippage occurs, traders can ensure they are positioned to take advantage of it.
How to Avoid Slippage
Slippage is the difference between the expected price of a trade and the actual price the trade is executed at. Slippage commonly occurs with market orders, which are orders to buy or sell a security at the best available price. When the market is rapidly moving, there may not be enough time for your order to fill at your expected price. In such cases, your order will likely be filled at a different, usually worse, price than you expected. This difference is called slippage.
To avoid slippage, traders can use limit, stop-limit, and stop-loss orders, among other tactics.
Stop-limit Orders
These orders allow you to set a maximum price that you are willing to pay (for a buy order) or a minimum price that you are willing to sell at (for a sell order). This way, if the market moves against you, your order will not be filled, and you will not suffer any slippage.
Stop-loss Orders
Stop-loss orders are another way to avoid slippage. A stop-loss order is an order that is placed to sell a security when it reaches a specific price. This price is typically below the current market price for long positions or above the current market price for short positions. Stop-loss orders can help you limit your losses if the market moves against you, but they can also cause you to sell your position at a loss if the market doesn’t move in the direction that you were expecting.
Avoid Trading During Major News Events
Finally, one of the best ways to avoid slippage is to avoid trading during major news events. These events can cause the market to move very quickly, and you may not be able to get your order filled at the price that you want. So, if a major news event happens, it’s usually best to sit on the sidelines and wait for it to pass before making any trades.
Entering Positions
When entering or exiting a trade, using a limit or stop-limit order can help to avoid slippage. With those order types, if you cannot get the price you want, you simply do not make the trade. While this may sometimes mean missing a lucrative opportunity, it also means that you avoid having your order filled at a worse price than you expected.
In contrast, using a market order ensures that you execute your trade. However, there is a possibility that you will end up with slippage and a worse price than anticipated. Therefore, it is ideal to plan your trades so that you can use limit or stop-limit orders whenever possible. Some strategies require market orders to get you into or out of a trade during fast-moving market conditions. Under such circumstances, be prepared for some slippage.
Exiting Positions
In the world of trading, it’s important to remember that you always have less control once money is on the line. When you’ve entered a trade, you may need to use market orders to exit quickly if the position is moving against you. Limit orders can also be used to exit under more favorable conditions.
For instance, a trader buys shares at $49.40 and then places a limit order to sell those shares at $49.80. With a limit order in place, the trader is guaranteed to receive $49.80 for the shares (or more if there is high demand). This is opposed to a market order, which would guarantee an exit from the trade but not necessarily at the desired price point.
As previously mentioned, another option for exiting a losing trade is to use a stop-loss limit order. This type of order will get you out of the trade when the price moves unfavorably, but it gives you a slightly better chance of receiving your desired price. Ultimately, it’s all about knowing your options and making the best decision for your particular situation.
Summary: Slippage
In conclusion, slippage is a risk that every trader faces. It can cause you to lose money, so it’s important to understand what it is and how to avoid it. By using limit and stop-limit orders, stop-loss orders, and avoiding trading during major news events, you can help minimize your risk of suffering from slippage.
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