Slippage occurs when the actual execution price differs from the expected price of an order. As a result, the fill price of an order is different than the price at which it was submitted. It most commonly occurs with market orders during periods of heightened volatility but slippage can also occur in large orders & limit (stop) orders as well.
The term “slippage” tends to have an unfortunate negative connotation. However, slippage is not always unfavorable for the trader, rather there is just a difference in the expected execution price.
Before exploring the intricacies of slippage, the following foundational components of trading are important to understand:
- There must be a buyer and a seller for a trade to occur. If one is attempting to sell a Crude Oil futures contract at 50.10, a counterparty must be willing to buy at 50.10, otherwise the order will be filled at the next available price.
- When using market, and stop market orders, the intent is for the trader to be filled as soon as possible, regardless of price. Submitting a market order is essentially saying, “I want to be filled at the best available price right away”.
3 Types of Slippage
With the above concepts in mind, below are 3 types of slippage that can occur. Crude Oil Futures is used as an example:
- Bid/Ask Price Fluctuation
A buy market order is submitted when the lowest offer is 50.10. A split second before the order hits the market, the lowest ask becomes 50.12 due to increased buying. In this instance, the order is filled at 50.12 with a slippage of 2 ticks. The expectation was 50.10, yet fill price was 50.12. Because the trader chose to submit a buy market order, to be filled as soon as possible, a small degree of slippage occurred.
- Partial Fills
A sell market order is submitted to sell 20 contracts at 50.10. On the bid side, there are two bids for a total of 20 contracts. The first bid is 13 contracts at 50.10 & the second is 7 contracts at 50.09. Per exchange matching rules, the ask for all 13 contracts will be filled at zero slippage. However, 1 tick of slippage will occur on 7 contracts at 50.09.
- Positive Slippage
This can occur when a market order is submitted and the best available price suddenly drops below the requested price during transit. A buy market order submitted at 50.10 is filled at 50.08 would result in positive slippage of 2 ticks.
Slippage Due to High Volatility
In times of extreme volatility, the following order types can experience a degree of slippage.
- Stop Orders
In a case of a large market spike, slippage can occur where the order is trigged before it can be filled as the market price moved beyond the stop price.
- Stop Limit Orders
It’s possible for the market to move far and fast enough that a stop does not get filled. Should this occur, the order transitions to a limit order at the highest or lowest user defined price.
Instances of large market swings are rare, however extremely volatile conditions have occurred surrounding news events. Traders should be aware of potential volatility & employ proper risk mitigation measures.