Understanding Slippage: Transaction Cost that Traders Must Master

When will slippage occur?

When you place a market order for trading, the final execution price may differ from your expected price, which is known as slippage. This usually occurs in two situations: first, when the market lacks sufficient liquidity to fully absorb your order; second, when the market is highly volatile, and prices change rapidly during the order execution.

The Relationship Between Spread and Slippage

To understand slippage, one must first clarify the meaning of spread (écart de cotation). The spread refers to the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept. The more liquid the market, the smaller the spread; assets with larger trading volumes (such as Bitcoin) typically have lower spreads.

The phenomenon of slippage in actual trading

Suppose you want to buy an asset at a price of 100 USD, but the current market lacks liquidity. Your large order may be executed at multiple prices higher than 100 USD, ultimately resulting in an average execution price significantly above your expectation. This price difference constitutes negative slippage, directly increasing your trading costs.

On the contrary, if the price movement is favorable to you, you may also gain positive slippage.

How Should Traders Respond to Slippage

Control order size

Splitting large orders into multiple smaller ones can effectively reduce the impact of single orders on the market, thereby decreasing Slippage.

Set Slippage Tolerance

Most decentralized exchanges and DeFi applications allow users to customize their slippage tolerance (such as 0.5%, 0.1%, or a custom percentage). This is a line of defense to prevent the execution of excessively unfavorable trades.

Pay attention to market liquidity

Markets with thin liquidity are more prone to slippage. Before deciding on a trade, assess the trading depth of the target asset.

Prefer to use limit orders

Although limit orders do not execute as quickly as market orders, they ensure that you only trade at the specified price or a better price, effectively preventing the negative effects brought by slippage.

The Art of Balancing Slippage Tolerance

Setting slippage tolerance requires finding a balance point:

• Slippage too low: Orders may be rejected or remain pending for a long time due to inability to execute within the slippage.
• Excessive Slippage: You will face the risk of unfavorable transaction prices.

This setting is particularly critical in decentralized exchanges and DeFi platforms.

Summary

For traders active in the market, understanding the concepts of Slippage and spread is crucial. Whether trading on centralized or decentralized platforms, mastering slippage management techniques can help you reduce hidden costs and make more informed trading decisions. Especially in the DeFi ecosystem, learning to set reasonable slippage tolerances and choose appropriate order types is fundamental to protecting your funds.