Dealing with Slippage in Cryptocurrency

Anyone who has conducted their own trades in any asset should be aware of slippage. However, this issue becomes even more of a problem in trading some cryptocurrencies. Slippage is the difference between the price you expect to get on the crypto you have ordered and the price you actually get when the order executes. 

It's important to calculate the slippage on any trade to limit any potential losses, but it can be a challenge when you're dealing with an asset that's as volatile as some cryptocurrencies. These tips will help you calculate the slippage on any order and show you how to limit the potential slippage when purchasing volatile cryptocurrencies.

Why slippage occurs in cryptocurrency trading

There are two primary reasons slippage occurs when trading cryptocurrencies: liquidity and volatility. When the price of bitcoin or other hugely popular cryptocurrencies changes rapidly, it is considered volatile because of how often it is being traded at varying prices. 

Volatility

Slippage occurs in this situation because the price changes so rapidly that the price at which the order executes has changed dramatically from the price at which the order was entered. The trader expects to get the price they enter the order at, but due to wild swings in the price, , their order executes at an entirely different price. 

Cryptocurrencies are still very speculative instruments due to their newness and, as a result, all it takes is a single headline to trigger a sizable increase or decrease in the price.

Liquidity

The other reason slippage occurs in cryptocurrencies is a lack of liquidity. Some cryptocurrencies are not traded very often due to their lack of popularity or newness compared to other cryptocurrencies. As a result, the spread between the lowest ask and the highest bid is wide, causing dramatic changes in the price suddenly — before an order that has been entered can be executed.

When an asset has low liquidity, it means it cannot be easily converted to cash. Less popular cryptocurrencies are somewhat illiquid because there may not always be buyers for them, meaning they can’t be converted into cash if no one wants to buy them. Low liquidity can cause significant slippage because with so few buyers, the number of asking prices will be few as well.

For example, liquid assets like blue-chip stocks will have investors listing their bids, or the amount they are willing to pay, at a wide range of amounts close to the current market price. However, illiquid assets like less-traded cryptocurrencies will have relatively few investors wanting to buy them. Sometimes there may be no willing buyers, so the seller will have to hold onto their cryptocurrency until someone comes along and buys it. Additionally, the price they are willing to pay may be significantly lower than what the seller wants to unload it for. 

Let’s say a seller has entered a market order to sell their cryptocurrency for $1.50, which allows them to sell it as soon as a buyer comes along at however much they want to pay. The seller ends up waiting two days for a buyer to materialize, but the buyer is only willing to pay 50 cents for it. 

Since it is a market order, it will be executed at whatever the current market price is. Since there is only one buyer offering to pay 50 cents, the market price of that cryptocurrency will plunge from $1.50 to 50 cents suddenly. The lack of buyers means there is a sudden jump in the market price through a single transaction.

How to calculate slippage

Slippage can be expressed two ways: in a dollar amount and as a percentage. Before you can calculate the percentage, you must calculate the dollar amount. This can be done by subtracting the price you expected to get from the price you actually got.

Slippage is not always bad. When the amount is negative, it denotes that you received a worse price than what you had expected. On the other hand, when it is positive, it shows that you received a better price than you had expected.

However, most trading platforms express slippage as a percentage, so it's important to know how to do that calculation in addition to calculating the dollar amount.. To calculate the percentage of slippage, divide the dollar amount of slippage by the difference between the price you expected to get and the worst possible execution price. 

Finally, you multiply it by 100 to convert it to a percentage. The worst possible execution price is the limit price you set when entering a limit order. Of course, this assumes that you're placing a limit order rather than a market order (more on that below).

In short:

$ of slippage / (LP - EP) x 100 = % slippage

EP = expected price

LP = limit price/ worst expected price

For example, let's say you want to buy one bitcoin for $47,000. However, you're not willing to pay more than $47,500. You enter a limit order when the price is at $47,000 with a limit price of $47,500. However, the order doesn't execute until the price rises to $47,250. Your slippage is -$250.

To convert that amount into a percentage, you divide $250 (the actual amount of slippage) by $500 (the difference between the price you expected to get and the worst possible execution price. The result is 0.5, which becomes 50% when you multiply it by 100 to convert it to a percentage.

How to combat slippage in cryptocurrency trading

With crypto prices changing so rapidly or suddenly, depending on whether volatility or liquidity is the reason for the slippage, it might seem like an impossible task to fight back against slippage. However, there are some tips and tricks that every trader should know before they start trading cryptocurrencies.

The most important way to limit slippage is to place limit orders for cryptocurrencies instead of market orders. Market orders are executed as quickly as possible at whatever the current price is, which means you have no control over what price you get when the order is executed.

However, market orders are almost guaranteed to be executed, especially when trading popular cryptocurrencies because there will almost always be an order going in the opposite direction of your order (buy vs. sell and vice versa).

Limit orders help you reduce slippage because you can set the highest possible price you are willing to pay for a cryptocurrency or the lowest possible price you are willing to sell a cryptocurrency for. However, they might never be executed because there is no guarantee that the price will stay within the boundaries you have set during the timeframe you have set.

Some crypto exchanges like Coinbase display slippage warnings if you are entering an order with a slippage percentage above a certain amount. Coinbase's warnings kick in at 2% slippage or higher.

Slippage can be a serious problem when trading cryptocurrency because of how volatile the market is. When prices change rapidly, the odds of a trader getting a different amount than what they expected to get are high. Additionally, low liquidity can mean sudden, jarring jumps in market prices when buyers don’t want to pay as much as what sellers want to sell for. Crypto traders should be prepared to deal with slippage, learn how to calculate it, and understand how limit orders can help them reduce or eliminate slippage.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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