Slippage has always been a major headache for crypto traders. This post will give you an in-depth understanding of slippage and how to avoid it.
TL;DR
- Slippage happens when there are differences between the expected and actual price.
- Slippage can be both positive and negative for traders.
- There are several ways traders can reduce slippage.
Introduction
Every crypto trader knows how volatile the crypto market can be and is aware of slippage. Slippage can both result in additional profit or loss for traders as a result of the high volatility.
In this article, we will look at slippage, how to calculate it, and ways to reduce slippage to maximize profits.
What is slippage?
Slippage refers to the difference between the price the trader expected to buy or sell their assets and the price they get. It is mainly common in cryptocurrencies as the market is highly volatile and fast-moving.
For traders that prefer to hold their assets long-term, a slippage of -0.5% is acceptable as the number of losses can be seen as pale compared to their huge investment.
In contrast, traders who regularly conduct transactions would prefer the lowest slippage possible, as a -0.25% loss in every transaction can result in a significant loss and eat up their profits. Hence, they tend to do everything to cut the slippage as much as possible.
What are Positive and Negative Slippages?
Slippage can be both negative and positive. If the percentage of slippage is below zero (negative), traders will suffer from a slight loss compared to their expected price. In contrast, traders can get a better price if the slippage is positive.
Positive or negative slippage depends on the time of the transaction. For example, if a trader executes a buy order at $15/ token, and the crypto price is lower than what the trader ordered, at $14/ token. It is called positive and gives the trader a better buying rate.
In contrast, if a trader wants to sell a token at $15/ token, but the order gets executed at $14, this is called negative, and the trader loses $1/ token.
How to calculate slippage?
Slippage can be both in dollars or percentages. The percentage form is the most common in most platforms nowadays.
To get the slippage rate, traders must first calculate the dollar by subtracting the expected price from the actual price.
The formula for calculating slippage is as follows:
*((Bid price – Ask Price)/ Quantity)100%
For example, it is 9:00 am, and the current token price is $100. You decide it is a reasonable price and want to buy one token. However, the transaction fill at $105. Then, your slippage would be: (100-105) *100%= 0.05%
With the limit order, the formula is more complicated:
*Price of slippage/ (LP – EP)100
- LP: the limit price
- EP: the expected price
For example, if a trader wants to buy one token at $100. However, his maximum budget for a token is $110. He enters a limit order when the token price is $100 with a limit price of $110. But, if the order executes at $105, the slippage would be -$5.
To convert it to a percentage, a trader has to divide the $5 by $10. The result is 50%.
What causes slippage?
Volatility
Prices can vary significantly between the time the trader enters the order and the time the order is executed. How much the price changes would depend on the current volatility.
Cryptocurrency is famous for its high volatility, as the price of one token can drop over 50% in hours. This is mainly because cryptocurrency is still a relatively new concept for everyone and remains a speculative instrument.
Low liquidity
The other reason for slippage is low liquidity.
Due to the lack of market participants willing to accept the other side of transactions, there is a longer delay between placing an order and having it executed. As a result, traders will suffer from a slippage.
How to prevent slippage effectively?
Slippage can be a severe issue when carrying out large orders. Therefore, there are various methods that traders can use to reduce the chances of slippage and maximize profit.
Use limit orders
Limit orders are one of the most common methods to reduce slippage on both centralized and decentralized platforms.
If you may not know, limit order is a purchase or sale carried out at the trader’s minimum price or higher.
Instead of using default market orders to execute the transactions as quickly as possible, limit orders help traders reduce slippage because the trader can control the highest price they are willing to pay for and the lowest price they are ready to sell at.
However, there is still the risk of the transaction not filling as the price may not stay within the expected range during the set timeframe
Trade during less volatile markets
Another way to minimize slippage is to trade during a less volatile market.
Traders should observe periods when major events can significantly affect the price of the crypto and choose the best timeframe for themselves.
Break up large trades
Large order means more slippage. By breaking up the order into several smaller ones, traders can reduce the slippage into smaller numbers. There may be more effective methods than this, but they still need to be considered when the transaction is significant.
Use DEX aggregators
DEX aggregators are great tools to minimize slippage in decentralized exchanges.
DEX aggregators use complex algorithms to find the best possible pricing options for traders to maximize their profits.
Ready’s smart algorithms also function in the same manner. The platforms constantly look for the best rates and suggest optimal exchange routes to users.
Final thoughts
Slippage can be a severe problem for crypto traders due to the volatile market. For the time being, users need to familiarize themselves with slippage and how it can affect their trading decisions. Traders need to know and put in place some basic steps to reduce slippage for the best pricing options.
