To understand the market conditions and how the trades are executed, as a beginner and a trader you must be aware of how the slippage works. Slippage crypto is a settlement difference in price for each trade that goes on. If you are trading on a centralized exchange or a decentralized exchange, such as Binance or Bitflex, there are chances that once you settle a trade you must be paying a slippage amount. To understand this in simple terms, slippage is the difference between an expected price and an actual price. The terms seem more confusing with how the spread works. But there is a thin line that differentiates both. And it has a lot to do with the liquidity, and popularity of the platform or protocol on which it is available. Let us see how liquidity interlinks both.
How Does Slippage Works?
To understand the concept of slippage and how as a trader you bear the two and many other unknown and known charges. Let us now understand the concept of Spread (Bid-Ask) price difference and what a trading platform does in this case.
Bid-Ask Price (Spread)
In case of a Bid-Ask spread, there are order books placed for any kind of pair or security. Whether you are doing online trading or have a mind to invest in crypto, you would come across these prices too. As the market closely depends on supply and demand principles, there are more chances for the highly liquid market or exchange to invite traders and buyers to trade. Liquidity plays a key role here. In the case of a crypto bid-ask spread, the rate is defined by the difference between the highest price placed in the order book to the lowest price of the order book.
Market participants are always into the spree of negotiations, about the spread between the buyers and the sellers. In determining the spread, the market makers or liquidity providers are also playing a key role. To determine the spread, there must be higher liquidity available to decide upon the spread rate. In case there is higher liquidity the bid-ask price spread would be narrower as there would be several orders placed in the queue. And buyers and sellers can execute their orders at much low-price fluctuations of Bid-Ask Spread.
Conversely, if there is less liquidity there are more chances for more spread price swings as it would take days to match up the orders and the least payable and highest salable price of an underlying digital asset or security. In short, the least asked price or selling price at which an asset is available is matched with the closest suitable bid price or buying price. Common traders do apply this tactic and make substantial profits by buying at the lowest market price and selling at the highest market price of the order book. A lower spread is mostly visible when there is tough competition between the market makers and in this way the spread gets lower. Along with this, a wider bid-ask price swing is seen when there are high-volume orders placed by the traders.
Slippage
The process of slippage starts when there are low liquidity levels available and high volatility present. The exchanges try their best to match your orders with the limit orders that are placed, and that results in slippage. The order books try to match your orders and volume for purchase at the lowest possible cost. Whereas it does not find, it tries to match up with the next possible least price range. In the end, you might have a lower expected price that would be suitable to you, and you will face a positive slippage. In congruence, if you have placed a sale order the order books would try to match your sell order with the highest possible market price and vice versa. Both these scenarios result in positive slippage.
Negative Slippage
The negative slippage is therefore the contrary term for when the orders are placed in a negative situation. Let us assume that you placed the order for a purchase order and instead the price order books match your order with the closest higher price, then you have faced negative slippage. If on the other hand when you place the sell order, the order books match your order to the closest highest price range. Instead of what price you have placed, you have faced negative slippage as well. For traders, negative slippage is a poking problem, and even this is unavoidable. Although the chances of negative slippage can be minimized.
Slippage Tolerance
To minimize the issue of slippage and that too in the volatile market, we commonly use slippage tolerance mechanisms. Some of them are as follows.
Order Splits
To cope with the fluctuating and volatile market, one should first go with the famous exchanges and platforms, offering high liquidity and more trading volume. But in case there is a slippage issue mushrooming up, we need to make certain changes for dividing our orders into factions and parts. This would help us bear the losses systematically and inculcate slippage tolerance at this level. When you divide your order into parts, you are offered different price ranges, and order books match your price to the limit price orders and therefore balance out your losses and minimize your risk alongside.
Implying Limit Orders
Another method to infuse slippage tolerance is to start using limit orders. With the help of limit orders, you can buy at the price you have placed. Although this might take time for order fulfillment. The exact price and amount are matched against your order. Therefore, before you make the order and bear slippage, make sure to wait and let the orders be matched to your desired price range.
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