How to Reduce Slippage in Algo Trading: Tips to Avoid Slippage
How to Reduce Slippage in Algo Trading: Tips to Avoid Slippage
Placing the orders or executing as per your expected is not possible in the stock market, especially in highly volatile underlying securities like options. The fluctuation in the price of the security makes difficult for the traders to place the orders as per their estimated price. There is always difference between expected price and price at which trade actually executed.
The difference between this expected price and the executed price can change your profitability or rate of return from the trading. Even automated software like Algo Trading is also facing such issues. However, this price difference between expectation and execution is called slippage in the stock market. Today in this article, we are going to discuss about slippage in tradingor in Algo trading.And how you can avoid or reduce slippage in Algo trading to maximize your profitability.
Slippage in Algo trading is simply the difference between the price of your trading security at which you ordered and the actual price at which the order had been executed. The slippage can be either positive or negative depending on the direction of price movement of the underlying security.
And this slippage occurs due to fluctuation in the price of the security that usually happens with the stocks trading under the options. When the volatility is high the price of the underlying security keeps moving up or down with quick changes making difficult to execute you order as per your expected or requested price creating the slippage.
The meaning of slippage in algorithmic trading and manual trading is broadly same. Difference lies, in manual trading a trader place order manually and adjusts its buy and sells levels as per price action in underlying. The slippages occur due to various reasons like psychology, eagerness to get into trade, impulsive trader, etc. In algorithmic trading, slippage is again the difference between the price quoted by the automated system and the actual price at which the transaction takes place.
In manual trading the price moves from your quoted price, you can modify your order price or cancel the order if still it comes again in your buying price range. However, in manual trading, you can use limit orders to place orders at certain specific prices.
While in automated trading with Algo, it could be difficult, as you can set conditions at which price your trade must be executed, if the price doesn’t come or bounce back from your limit order price even with a minor difference then you can miss the transaction.
In Algo trading the slippage can cost your transaction as a huge number of transactions take place in the shortest time period with a huge volume of trades. However, the slippage in Algo is lower than the manual trading, as the speed of transaction or order execution is much faster than in manual trading. But still, the slippage needs to be avoided in Algo too.
Though, In Algo, you can set conditions of price range like less than or greater than the price at which your trade should be executed, but still there is a chance of slippage. Hence, reducing the slippage in trading, especially in Algo trading is very important to minimize the cost of acquisition and maximize theoverall profitability of transactions in trading and Algo trading.
However, there could be multiple reasons behind the slippage in trading. And in automated trading system like Algo trading there could be some more additional causes that can affect the transactions and execution process in trading. Let’s find out the main causes of slippage and how you can avoid this or reduce occurrence with right approach.
Delayed Order Execution: Automated software like Algo can place the order at a very fast speed compared to humans. However, the order execution in an automated system can be also delayed due to various factors like system slowdown, network latency and trading platform latency. A technical malfunction or system breakdown can delay order execution.
Market is Highly Volatile: When the market is highly volatile, the index or price of the underlying security keeps fluctuating making it difficult to place the order at a specific price.The swing in price will not allow you to trade at your desired price, the slippage will occur.
Lack of Liquidity: When the volume of trade in a particular security is low, there is also a lack of liquidity, making it difficult to execute the trade at the expected price. Low liquidity in the market means the buyers and sellers are both limited; hence, they quote their trade prices with huge differences. The price difference in the order book also causes price slippage.
Large Trades or Bulk Deals: When there is a large quantity of orders placed in a particular security or bulk deal of transactions take place, the price can change from your desired levels. The Large deals or bulk orders are also responsible for slippage in trade.
Types of Orders: There are certain types of orders in Algo trading like basket orders, limit orders, GTC orders, bracket orders market orders etc. The price of the security is also affected due to the use of certain orders at large scale. Market ordersare also one of themthat are executed at the current market price, and if it does not match your price, the slippage will occur.
Placing the orders with limit orders is one of the best ways to avoid slippage in trading. In limited order, you can quote your order with a specific price that will be executed only when the price reaches that specific price. If your order is not executed during trading hours, it will be cancelled. However, you can also place limited orders with time duration.
The chance of slippage is very high when the market is highly volatile. To avoid slippage in such market conditions you can avoid trading or don’t choose to trade stock with high implied volatility (IV). Always check the VIX to know the volatility level of the market and keep you updated with news or events likely to come that can influence the price of individual stocks.
In Algo trading to avoid slippage due to volatility, you can choose the highly liquid stocks. A stock with high liquidity means the participants in the market are very active from both sides and your orders would be executed near about your expected price. While in option trading you can trade with hedge positions to avoid the impact of volatility.