Slippage (finance)

This article is about the financial concept. For other uses, see Slippage.

With regard to futures contracts as well as other financial instruments, slippage is the difference between where the computer signaled the entry and exit for a trade and where actual clients, with actual money, entered and exited the market using the computer’s signals.^[1] Market-impacted, liquidity, and frictional costs may also contribute.

Algorithmic trading is often used to reduce slippage, and algorithms can be backtested on past data to see the effects of slippage, but it’s impossible to eliminate entirely.^[2]

Measurement

Using initial mid price

Nassim Nicholas Taleb (1997) defines slippage as the difference between the average execution price and the initial midpoint of the bid and the offer for a given quantity to be executed.

Using initial execution price

Knight and Satchell mention a flow trader needs to consider the effect of executing a large order on the market and to adjust the bid-ask spread accordingly. They calculate the liquidity cost as the difference of the execution price and the initial execution price.

Concrete Example

Slippage Example on the SPY ETF

The associated image depicts the Level II (Market Depth) quotes of the SPY ETF (Exchange-Traded Fund) at a given instant in time.

The left hand side of the image contains the market depth for the current BID prices and the right hand side of the image contains the market depth for the current ASK prices. Each side of the image contains three columns:

MM Name: This is the Market Maker name column
Price: This is the "market depth" price.
Size: This is the number of shares at this price level (represented in hundreds). So, 2 actually means 200 shares.

The top left of the image represents the current BID price ($151.07) and the top right of the image represents the current ASK price ($151.08). At the $151.07 bid price point, there are 300 shares available (200 by the ARCA Market Maker and 100 by the DRCTEDGE). At the $151.08 ask price point, there are 3900 shares available (2800 by the ARCA Market Maker and 1100 by the BATS Market Maker). This is typically represented in quote form as: $151.07 X 300 by $151.08 X 3900).

To properly understand slippage, let's use the following example: Say, you (as a trader) wanted to purchase 20,000 shares of SPY right now. The problem here is that the current ASK price of $151.08 only contains 3900 shares being offered for sale, but you want to purchase 20,000 shares. If you need to purchase those shares now, then you must use a market order and you will incur slippage by doing so. Using a market order to purchase your 20,000 shares would yield the following executions (assuming no hidden orders in the market depth):

Buy 2800 @ $151.08
Buy 1100 @ $151.08
Buy 3800 @ $151.09
Buy 900 @ $151.10
Buy 3700 @ $151.11
Buy 1200 @ $151.12
Buy 3700 @ $151.13
Buy 200 @ $151.14
Buy 1000 @ $151.15
Buy 400 @ $151.18
Buy 100 @ $151.22
Buy 600 @ $151.24
Buy 500 @ $151.25 (only 500 shares out of the 2000 being offered at this print point are executed, because this will represent our entire 20,000 share order).

The average purchase price of the above execution is: $151.11585. The difference between the current ASK price ($151.08) and your average purchase price ($151.11585) represents your slippage. In this case, the cost of slippage would be calculated as follows: 20,000 X $151.08 - 20,000 X $151.11585 = $-717.00

Reverse Slippage

Reverse slippage as described by Taleb occurs when the purchase of a large position is done at increasing prices, so that the mark to market value of the position increases. The danger occurs when the trader attempts to exit his position. If the trader manages to create a squeeze large enough then this phenomenon can be profitable.

References

Financial markets

Types of markets	Primary market Secondary market Third market Fourth market

Types of stocks	Common stock Golden share Preferred stock Restricted stock Tracking stock

Share capital	Authorised capital Issued shares Shares outstanding Treasury stock

Participants	Broker-dealer Day trader Floor broker Floor trader Investor Market maker Proprietary trader Quantitative analyst Regulator Stock trader

Exchanges	Electronic communication network List of stock exchanges Opening times Multilateral trading facility Over-the-counter

Stock valuation	Alpha Arbitrage pricing theory Beta Bid–ask spread Book value Capital asset pricing model Dividend discount model Dividend yield Earnings per share Earnings yield Net asset value Security characteristic line Security market line T-model

Trading theories and strategies	Algorithmic trading Buy and hold Concentrated stock Contrarian investing Day trading Dollar cost averaging Efficient-market hypothesis Fundamental analysis Growth stock Market timing Modern portfolio theory Momentum investing Mosaic theory Pairs trade Post-modern portfolio theory Random walk hypothesis Sector rotation Style investing Swing trading Technical analysis Trend following Value investing

Related terms	Block trade Cross listing Dark liquidity Dividend Dual-listed company DuPont analysis Efficient frontier Flight-to-quality Haircut Initial public offering Margin Market anomaly Market capitalization Market depth Market manipulation Market trend Mean reversion Momentum Open outcry Public float Public offering Rally Returns-based style analysis Reverse stock split Share repurchase Short selling Slippage Speculation Stock dilution Stock market index Stock split Trade Uptick rule Volatility Voting interest Yield

Derivatives market

Derivative (finance)

Options

Terms	Credit spread Debit spread Exercise Expiration Moneyness Open interest Pin risk Risk-free interest rate Strike price the Greeks Volatility

Vanilla options	Bond option Call Employee stock option Fixed income FX Option styles Put Warrants

Exotic options	Asian Barrier Basket Binary Chooser Cliquet Commodore Compound Forward start Interest rate Lookback Mountain range Rainbow Swaption

Combinations	Collar Covered call Fence Iron butterfly Iron condor Straddle Strangle Protective put Risk reversal

Spreads	Back Bear Box Bull Butterfly Calendar Diagonal Intermarket Ratio Vertical

Valuation	Binomial Black Black–Scholes model Finite difference Garman-Kohlhagen Margrabe's formula Put–call parity Simulation Real options valuation Trinomial Vanna–Volga pricing

Swaps

Exotic derivatives

Other derivatives

Market issues

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