Slippage is the difference between the expected price and the actual price received on an order while trading.
There’s a favorable and unfavorable slippage. Favorable slippage is when you get a better price than expected, while unfavorable slippage means you get a worse price.
Slippage is also referred to as a “bad fill” or “good fill” in relation to getting an unfavorable or favorable price on the order.
Assume you place a market order to buy at stock with a current offer price of 125.26. There are 500 shares offered at that price, and since you are only buying 100 shares you think you will get the 125.26 price.
(Note: understanding slippage requires understanding the bid and ask/offer prices.)
That may happen, but prices change quickly. By the time your order is executed, you may end up paying 125.35 (0.09 slippage) or you may get 125.23 (0.03 favorable slippage).
Or maybe you want to short sell and the bid price is 25.69. You place a market sell order. The order may fill at 25.69, or it may fill at 25.68 or 25.70 (0.01 slippage in both cases).
Slippage is most common on market orders, which many people use for entering trades and for stop loss orders.
Slippage on a stop loss order looks like this. You bought a stock 65, but want to get out if the price drops to 63 or below. You place a stop loss order at 63. Your order is executed when a transaction occurs at 63. But if the stock price closed at 63.10 today and opens tomorrow at 62.50, the stop loss order will execute at 62.50 since that is the first price available below 63.
If a transaction occurs at 63 during the day, the order is sent and will likely fill near 63, but not necessarily exactly at 63. If it fills at 62.90, that’s 0.10 of slippage.
What Causes Trading Slippage
Slippage happens for several reasons.
- Another party cancels their bid or offer just before your order is processed, which changes the price your market order will execute at. This happens regularly throughout the day.
- Someone else buys/sells the shares before you; you get the next best price. With many transactions going through each minute, and even each second in some securities, the bid and ask prices can change very quickly which will affect what price you get on your orders.
- Your order is bigger than what is available at the current bid or offer. For example, if there are only 100 shares for sale at 25.26, 100 at 25.27, 100 at 25.28, and 100 at 25.29, and you want to buy 400 shares, then assuming nothing changes you will buy all the shares available from 25.26 up to 25.29 for an average fill price of 25.275.
- Slippage can result from a combination of all these factors.
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Limit Orders to Reduce Slippage
Slippage is most common with market orders. A market order takes any price it can get. It’s good for getting in and out of something as quickly as possible. The downside is that you don’t always know the price you’ll actually get.
Limit orders control the price the order executes at.
If you want to buy at 12.65, you can place a limit order to buy at 12.65. If that price, or lower, is available right now, your order will execute at the best price available up to and including 12.65.
If that price isn’t available, then your order will sit there, as a bid at 12.65. Someone will need to sell to you at that price to fill your order.
Limits are commonly used on entry orders, as are market orders.
Stop losses are typically market orders, but can also be stop limit orders. A stop limit order only executes within a specified price band. Assume you short sell at 32, and you want to get out if the price rises to 33. But if the price gaps through 33 and above 33.50 you will hold onto the shares and see if you can get out at a better price down the line. You place a stop loss limit (buy stop limit in this case) with a stop at 33 and a limit at 33.50. This means you will only get filled between 33 and 33.50.
If the price jumps above 33.50 (with no transaction between 33 and 33.50), you still have a short position; if the price falls back below 33.50 the order will execute and your trade will be closed.
Essentially, no matter the context, adding a limit controls the price our order executes at. Sometimes this is worth doing. Other times, it may mean missing an entry or exit where a market order would have worked better.
For example, a buy-stop-limit-order buys when the asset moves above a specified price, but will only pay up to the limit price. This avoids paying too high of a price if the asset gaps above the stop price.
One order isn’t better than another as they each do different things. Use the appropriate order type for the context. If you need to get in or out quickly, use a market order. If you want to control the price paid or sold at, use a limit.
I use a combination of limit and market orders for my entries. For stop losses, I always use market orders because I want to get out immediately if the price goes through my stop loss price.
Other Ways to Avoid Slippage
There are a number of factors that contribute to slippage. Avoiding them can help reduce the negative effects of slippage.
- High volatility stocks/assets
- Low daily volume in the asset
- Price gaps
If a stock is highly volatile but also has lots of volume, slippage is likely to be minimal. If a stock has low volume but doesn’t move much, then slippage isn’t likely to be a problem.
But if a stock has low volume and is volatile, expect lots of slippage.
Price gaps mean the price changes from day to day without any transaction occurring within the gap. Certain stocks are prone to constant gapping, such as foreign companies listed on the US market. Because these companies often trade on another exchange/in another country, when the US market opens the price opens to reflect the trading that has already taken place on the other exchange.
New Oriental Education & Technology Group (EDUon NYSE) is a good example of this. The price gaps nearly every day relative to the prior close.
EDU chart by TradingView
Price gaps can also occur as a result of earnings announcements or other major news events. These events may cause a rapid change in sentiment where large orders remove all available shares (or whatever asset) near the last price; the next order receives a very different price than expected. These events may also cause people to cancel their orders, which means the next transaction to occur may be at a very different price than the last.
It’s not always possible to avoid price gaps, and some gaps take us by surprise. But we can be prepared and weigh the pros and cons of possibly holding through a gap if we know it’s coming.
Major economic events (which are scheduled in advance…such as Federal Reserve interest rate announcements) and earnings announcements can rapidly change the price and create slippage on orders. Consult an Earnings Calendar and Economic Calendar for the market you’re trading.
Before holding through or placing trades right around these times, consider the consequences.
Slippage is Part of Trading
Slippage is a part of trading. It can’t be totally eliminated. We’re going to get different prices than we expected or want sometimes. This is especially true when using market orders. But limit orders can also mean missing out on a trade that moves quickly or getting stuck in a loss that keeps getting worse.
Think of slippage as a cost charged by the market. Sometimes we get a bit better price than expected, and sometimes we get a bit worse. Usually, slippage is quite small, and has little impact on overall profitability. But it can, occasionally, be a very big deal.
Potentially catastrophic slippage is when the price gaps a huge amount against you. There’s no chance to get out and you end up facing a massive loss.
Assume you bought a stock at $5. It’s trading along then, all of a sudden, one day it opens at $2. The company said overnight that it’s financially distressed and may be forced into bankruptcy. Overnight you and the stock lost 60%.
This happens. And it can happen in seemingly great companies. It may not be bankruptcy, but a company may announce it just lost a big contract, it’s being sued, one of its employees embezzled a bunch of money, it didn’t get a patent, and so on. Bad news isn’t always forecastable.
Holding through earnings is a bit of a gamble. We know that earnings can cause big price moves and sometimes big gaps.
Netflix (NFLX) had two earnings drops of more than 20% in the first half of 2022. Prior to this, NFLX was seen as a stable company with good growth prospects.
This is not to say don’t hold through earnings. It just means be aware that there’s a heightened risk of price gaps when holding through earnings.
Whether slippage is catastrophic to a trader or investor largely depends on position size.
If an investor has their entire net worth invested in one stock and that stock drops 60%, that’s a pretty bad day!
If someone has their money in 10 different stocks, or 50, and one drops 60%, that still stings but not as much as the prior investor.
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Slippage for the Win
Sometimes slippage gives us a really big win. Just as the price can gap against us, it can also gap favorably. A stock may jump 50% overnight on positive news, earnings, or a buyout offer (another company offers to buy the company we have shares in), for example.
If we purchased a stock at 50 and we place an order to sell it at 60, if the price gaps above that, we get the next available price. If that next available price is 75, we just made 15/share more than expected. Bonus. Such events help offset the negative slippage that we will also inevitably experience.
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Get into trades as the price is starting to run, and typically make 20% within a couple of weeks. Slippage is typically minimal since trades are not held through earnings.
Cory Mitchell, CMT
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.