Updated on March 13, 2019
To be a successful stock trader, you must understand slippage and how to minimize it. No, we aren’t talking about walking on a wet floor and falling, we’re instead calling to attention one of the main aspects of trading stocks that eat away at an investor’s profit. Slippage is where an investor expects to buy or sell a stock at a certain price but receives a completely different one. This situation usually happens due to buying and selling stocks with rapidly changing prices. Stock prices tend to move very quickly due to factors like earnings results, news, or just normal buying and selling pressures.
The Culprit: Market Orders
Slippage specifically occurs when investors use Market Orders within these fast-moving markets. This is because a Market Order tells your broker to buy or sell a stock at the best available market price. When stock prices are moving fast, the best available price in the market` may be a lot different than the price of the stock currently.
As an example, let’s say you want to buy a very popular stock after positive breaking news about the company. The stock is currently $100 a share but begins to rise very quickly due to the fact many other investors are wanting to buy the stock as well. If you submit a Market Order while the stock is moving rapidly, it is very likely that it will execute at price higher than the stock’s price when you submitted the order. This is a classic case of slippage, causing you to pay more money than you expected.
Slippage With Large Orders
Slippage can also occur when large orders cannot be fully executed at one price. In this situation, some shares are bought at prices further away from the current price of the stock in order to fulfill your request.
Over a long period of time, slippage can decrease your profits tremendously. To prevent slippage, you should mostly utilize limit orders. Although limit orders have the risk of never being executed, they ensure your order is executed at the desired stock price. Also, to minimize slippage, you should try trading while the market is quiet instead of while investors are trying to trample each other to buy or sell a stock.