Types of Orders and Slippage
Slippage occurs when a trader receives a different price than expected when entering or exiting a trade. Market orders expose traders to slippage because they may allow the trade to be executed at a worse price than anticipated. Traders can use limit orders and stop-limit orders to prevent trading above or below a specified price and avoid slippage. Stop-loss orders can also be used to minimize slippage when the stock price moves unfavorably.
Entering Positions
Limit orders and stop-limit orders (not to be confused with stop-loss orders) are often used to enter positions. With these types of orders, if you cannot get the price you want, simply do not trade. Using a limit order may mean you miss a profitable opportunity, but it also means you avoid slippage.
Using a market order ensures the trade is executed, but there is a possibility of slippage and receiving a worse price than you expected. In fact, you should plan your trades so that you can use limit orders or stop-limit orders to enter or exit positions and avoid unnecessary slippage costs. Some strategies require the use of market orders to enter or exit a trade during fast-moving market conditions. In such cases, be prepared for some slippage.
Exiting Positions
If you are already in a trade and have money on the line, you have less control than you did when entering the trade. You may need to use market orders to exit the position quickly. Limit orders can also be used to exit in more favorable conditions.
For example, suppose a trader buys shares at $49.40 and places a limit order to sell those shares at $49.80. The shares are sold only if someone is willing to pay the trader $49.80. There is no possibility of slippage here. The seller will receive $49.80 (or more if there is demand).
When setting a stop-loss order (an order that exits you when the price moves unfavorably), you may use a market order. This will ensure you exit the losing trade but not necessarily at the desired price. Using a stop-loss limit order, the order will be executed at the price you want unless the price moves against you. Your losses will continue to rise if you cannot exit at the specified price. For this reason, it is better to use a market stop-loss order to ensure that your losses do not escalate, even if it means facing some slippage.
When Does the Largest Slippage Occur?
The largest slippage typically occurs around major news events. As a day trader, avoid trading during scheduled major news events, such as FOMC announcements or corporate earnings reports. Although large movements seem attractive, entering and exiting at the price you want can be difficult.
If you are already in a position when news is released, you may experience significant slippage on your stop-loss order, exposing you to much greater risks than you anticipated. Check the economic calendar and earnings schedule to avoid trading just a few minutes before or after announcements marked as having a significant impact.
Risk Management During Announcements
As a day trader, you do not have to hold positions before those announcements. It will be more beneficial to take a position afterward as it reduces slippage. Even with this precaution, you may not be able to avoid slippage with unexpected announcements, as slippage tends to be substantial.
If you do not trade during major news events, it is likely that significant slippage will not be an issue, so using a stop-loss order is recommended. If a disaster occurs and you experience slippage on your stop-loss order, you may face a much larger loss without the presence of a stop-loss order.
Managing
Risks do not mean that there will be no risks at all. It means that you minimize risks as much as possible. Don’t let slippage deter you from managing risk in every possible way.
Slippage is Common in All Markets
Slippage also occurs in markets that are thinly traded. You should consider trading stocks, futures, and currency pairs with adequate volume to reduce the likelihood of slippage.
You can also trade stocks and futures when major U.S. markets are open (if you’re trading in the U.S.). Another idea is to trade in the forex market when London and/or the U.S. are open, as that is the most liquid and active time for most currency pairs.
You cannot completely avoid slippage. Consider it a variable cost of doing business. When possible, use limit orders to enter positions that reduce your chances of higher slippage costs.
Use limit orders to exit most winning trades. If you need to enter or exit a position immediately, you can use a market order. When placing a stop-loss order, you can use a market order. Market orders are subject to slippage, but a little slippage is acceptable if you need to execute your trade quickly.
Frequently Asked Questions (FAQs)
What is slippage tolerance?
Slippage tolerance is the order detail that effectively creates a limit order or a stop-limit order. This term is more common in digital trading platforms. In markets offered by traditional brokers such as stocks, bonds, and options, you would use a limit order instead of setting slippage tolerance. With slippage tolerance, you define a percentage of the trade value that you are willing to accept in slippage. For example, if a trader sets a slippage tolerance of 2% to buy $100 of Bitcoin, this order may actually cost up to $102. If the cost exceeds $102, the order will not be executed.
How large should the stock volume be to avoid slippage?
This question ultimately depends on personal preference. Most traders will find a volume threshold where their strategy operates efficiently. To ensure you minimize slippage risks, you may want to look for stocks with high volume that trade tens of millions of shares daily.
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What is slippage tolerance?
Slippage tolerance is the order detail that effectively creates a limit order or a stop-limit order. This term is more common in digital trading platforms. In markets offered by traditional brokers such as stocks, bonds, and options, you would use a limit order instead of setting slippage tolerance. With slippage tolerance, you define a percentage of the trade value that you are willing to accept in slippage. For example, if a trader sets a slippage tolerance of 2% to buy $100 of Bitcoin, this order may actually cost up to $102. If the cost exceeds $102, the order will not be executed.
How large should the stock volume be to avoid slippage?
This question ultimately depends on personal preference. Most traders will find a volume threshold where their strategy operates efficiently. To ensure you minimize slippage risks, you may want to look for stocks with high volume that trade tens of millions of shares daily.
Was this article helpful?
Thank you for your feedback!
Let us know why!
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What is slippage tolerance?
Slippage tolerance is the order detail that effectively creates a limit order or a stop-limit order. This term is more common in digital trading platforms. In markets offered by traditional brokers such as stocks, bonds, and options, you would use a limit order instead of setting slippage tolerance. With slippage tolerance, you define a percentage of the trade value that you are willing to accept in slippage. For example, if a trader sets a slippage tolerance of 2% to buy $100 of Bitcoin, this order may actually cost up to $102. If the cost exceeds $102, the order will not be executed.
How large should the stock volume be to avoid slippage?
This question ultimately depends on personal preference. Most traders will find a volume threshold where their strategy operates efficiently. To ensure you minimize slippage risks, you may want to look for stocks with high volume that trade tens of millions of shares daily.
What should be the size of stocks to avoid slippage?
This question ultimately depends on personal preference. Most traders will find a size threshold that works efficiently for their strategy. To ensure you minimize the risk of slippage, you may want to look for stocks with large volume that trade tens of millions of shares daily.
Was this article helpful?
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Source: https://www.thebalancemoney.com/day-trading-slippage-defined-1030866
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