Market Order Slippage
Market order slippage is a concept in trading which refers to the difference in the expected execution price of the market order and the actual price the order was filled at. Market orders are orders which are bought or sold at the prevailing market price, which fluctuates all the time, making it uncertain as to what price the order will be filled at. When this difference is greater than expected, it is referred to as slippage.
Market order slippage is primarily caused by liquidity in the market. When there is a great deal of liquidity, that is, a large number of buyers and sellers who are willing to transact at the current market price, then execution of a market order is likely to be quick and at the expected price. But if there is limited liquidity, the likelihood is that the order is need to be filled slowly and at a price which is different than the expected one.
In addition to low liquidity, market orders can also be affected by large orders as well. If a trader submits a market order to buy or sell a large number of shares, many other market participants may try to anticipate the order and move the current market price, thus increasing the slippage.
Market order slippage can affect any investor, regardless of their experience level or the nature of the order. Retail investors can be affected due to their order size and the generally small size of the market makers in the equity markets. Institutional traders are affected to a lesser degree, due to the large size of their orders and the presence of more sophisticated market makers who are able to account for numerous variables in executing trades.
Despite the uncertainties of market order slippage, there are steps investors can take to minimize the impact. One of the primary methods of reducing the impact of slippage is to use limit orders. With a limit order, you specify the price you are willing to buy or sell a security at. Thus, the order won’t be executed until that price is reached, which reduces the chance of slippage.
In addition, it is also beneficial to split a large order into several smaller orders which are spread out over a period of time. This helps to reduce the market impact of the order, as it is not as clear to other market participants that a large order is being filled. Also, one should also be aware of the potential slippage that can occur during and after earnings releases, as the liquidity can dry up quickly and the market can move quickly.
Finally, it is also important to take into account the cost of the commission when placing orders. Commissions can add up quickly if one is placing many trades and the cost of commission should be taken into account when making trading decisions. This will help to reduce the impact of slippage, as it ensures that the order is placed with a certain level of expectation as to what the execution price should be.
Overall, market order slippage is an unavoidable consequence of trading and can affect investors, regardless of their experience level. By taking the necessary steps to ensure that your orders are well-executed, it is possible to reduce the impact of slippage in order to ensure that you obtain an optimal outcome.
