Do you know how to avoid slippage? Before we get to that, we want to ensure you know what slippage in trading is. It’s important! There are a lot of things you want to avoid in the market, and this is one that you want to avoid at all costs. And one that inevitably occurs to all traders, who learn the hard way: Slippage.
And no, I’m not referring to what happens when you wear heels on ice. Slippage is a common phenomenon in the stock market. Indeed, it’s one you want to avoid like the plague, or it will eat away at your profits…or compound your losses.
Today, I will show you how to avoid slippage before you see for yourself if your feet can go over your head.
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How to Avoid Slippage Introduction
Humor me for a minute as we use your car as an example. Imagine you pull your car up to the pump to get gas and notice the price is $4.93 a gallon.
After letting out a long sigh, you decide to fill your tank up because you’re not going anywhere without gas.
However, in the time it takes to pump the gas and walk inside to pay, something may change, or the quote is delayed. Shockingly, when you go inside to pay, you’re charged $4.96, $0.03 more than your expected price of $4.93 – what the heck?!!
We call this difference in the bid/ask (pump price/cashier price) spread and slippage in the financial world. Or the difference between a trade’s expected price and the actual price of execution.
Why Does Slippage Occur?
Sometimes, I wish I had a crystal ball to tell me why or what would happen. Now that I think of it, it would be useful in stock market trading.
As it stands now, I have no crystal ball. But, what I do have is evidence from the past. We see slippage occurring when market orders get placed during times of high volatility in the market.
We also experience slippage when large orders get placed without enough buyers at the table interested in buying the asset.
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What Is Slippage With Market Orders?
Slippage occurs when a trader uses market orders.
To refresh your memory, if you’re placing a market order, you tell your broker to buy or sell the stock for you immediately at any price. Yes, at any price.
Aside from being hasty, if you place a market order, you have no control over the fill price. You get filled on the wrong side of the bid-ask spread. A market order buys at the ask (high side) and sells at the bid (low side).
In the trading arena, for example, if the bid-ask spread is $12.00-$12.02, market orders should buy immediately at $12.00 for you. Right? Wrong.
By the time your market order arrived at the Exchange, the stock had soared on the news to $12.15. Unfortunately for you, your buy market order gets filled at $12.15 – a 15-cent slippage. And that is bad, really, bad.
The solution? Use limit orders instead of market orders.
Unlike a market order, a limit order only fills at the price you want or better. The keyword here is limit; a limit order limits the price you will pay for the stock.
You tell your broker to buy or sell a specific stock at or better than a specified price to avoid slippage. You are in control of your trades, and this should be your ultimate goal.
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How to Avoid Slippage When Entering Positions
We have a few different order types, from limit orders to stop-limit orders to enter a position. Please remember not to confuse stop-limit orders with a stop loss; they are different.
I encourage you to review our blog posts on the different types of orders to refresh your memory.
Use a limit or stop-limit order to avoid slippage when entering a position. The only downside here is that you may miss a good move.
So if you can’t get the price you want, you don’t trade; it’s better to be safe than sorry; especially when learning to avoid slippage.
Exiting Positions
Here is a nugget of wisdom I have gleaned from my time trading that I thought I should share with you: Stop worrying about how you enter a trade. The key is to know at all times when you will exit.
Depending on the situation, there are a few ways to exit a position. Firstly, if you’re in a trade and need to get out quickly for whatever reason, you may need to use a market order.
Again, this will guarantee an exit from your losing trade, but not necessarily at your desired price.
However, if you’re in a trade going your way, placing a limit order at your target price makes sense. Assume you buy shares of $FB at $150.50 and set a limit order to sell at $150.90.
Your limit order only sells your shares if someone will give you $150.90 for them. In this scenario, slippage is impossible, and you get $150.90 (or more).
Using a stop-loss limit order will only fill at the price you want. This means when the price moves against you, your loss will continue to rise if you can’t get out at the specified price.
In light of this, it is better to use a stop-loss market order to ensure the loss doesn’t get any bigger than it already is, even if it means incurring some slippage.
When to Expect the Most Slippage
Just like the predictability of the sun rising and setting every day, the impact of significant news events on the market is just as predictable.
I’m sure you can recall when the market responded to major news (i.e., trade wars), such as SEC investigations or a company that failed to make earnings.
Or better yet, a company whose share price tanked over a simple tweet. We all know that earnings times, particularly, are times of volatility. Although the significant price moves may be alluring, they can also be dangerous.
Once in a trade, you might find getting out difficult and experience slippage on your stop loss. The result: your account is exposed to more risk than it should.
To avoid this, check the economic and earnings calendar and steer clear of trading before these announcements.
Everyone would be rich if acting on news, stock tips, and financial reports were the keys to trading success. It would be best to keep in mind that profits in day trading aren’t made from trading the news. Check out quantdata for up-to-date news and company reports.
Another scenario we will inevitably run into is the surprise news announcements. They are rare, but the slippage might be substantial when they occur. So, to prevent this, have a stop loss in place; otherwise, you’ll be staring down the barrel of a massive loss.
We also see slippage in markets that trade thinly with low volume and large bid-ask spreads. To prevent this, ensure sufficient volume and float; my preference is a minimum volume of 300,000 with a tight bid/ask spread.
How to Prevent Slippage
I will give you some key points to manage your risk and help prevent slippage:
- Use limit orders to get into positions and use them when getting out of most of your profitable trades.
- Use a market order if you need out immediately, meaning pure speed. Or consider a “sell the bid” type order that immediately targets the current bidder.
- When placing a stop loss, use a market order.
- Avoid trading for several minutes around major news announcements. Wait for the price to stabilize or a trend or pattern to appear/
Final Thoughts: How to Avoid Slippage
You can’t wholly avoid slippage; consider it a cost, like commissions. Sometimes, it’s a cost worth paying, but not always.
Stock traders can avoid slippage during volatile market conditions by not placing orders unless necessary. The surest way to prevent slippage is to apply a guaranteed stop (limit) order.
Note that this is not a stop-loss order but a guaranteed limit order that will always complete trades at the price you set.
I know all this information can seem and feel overwhelming, but we can all learn to trade for a living if we want to. So, if you’re serious and ready to start your trading journey, let us help you. We make it simple and easy to understand; no slipping is required!
