Explaining Bid-Ask Spread and Slippage in Crypto Trading

Tue May 02 2023

Bid-Ask, Spread and Slippage can significantly impact your trading results whether employing manual or algorithmic trading strategies. Here's what you need to know about them.

To effectively trade cryptocurrencies as well as other asset classes, it is vital to comprehend the concepts of bid-ask spread and slippage as they can have a significant impact over your trading strategy, especially if you’re employing an algorithmic crypto trading strategy that places multiple trades a day.

Brief overview of Bid-ask spread and slippage

Simply put, the bid-ask spread refers to the gap between the lowest ask price and the highest bid price on an order book. This spread arises from the ongoing negotiation between buyers and sellers, leading to differing prices. An asset’s liquidity and trading volume play a significant role in determining the size of the bid-ask spread. More liquid assets, like Bitcoin and Ethereum tend to have a smaller spread compared to less liquid ones.

Slippage is the phenomenon where a trade is settled at an average price that differs from the initially requested price. It is common when executing market orders and typically occurs in situations with low liquidity or high market volatility. To tackle slippage when trading low-liquidity assets, traders can break their orders into smaller segments also known as partial order filling. For instance there may not be an immediate ask for 1 whole ETH to match your bid, but there may be several smaller ask orders waiting.

Bid-Ask Spread Explained

In crypto markets, unlike conventional Forex and stock, the spread results from the discrepancy between limit orders placed by buyers and sellers. When conducting an instant market price purchase, traders must agree to the lowest ask price offered by a seller. On the other hand, when executing an instant sale, traders must accept the highest bid price from a buyer.

Market makers play a vital role in generating liquidity in financial markets. They capitalize on the bid-ask spread by simultaneously buying and selling an asset. By purchasing at the lower bid price and selling at the higher ask price, market makers can pocket the spread as arbitrage profit. In the case of high-demand assets, market makers compete to reduce the spread, resulting in smaller spreads.

Demystifying Slippage

Slippage often occurs in markets characterized by high volatility or low liquidity. It takes place when a trade is settled at a price that differs from the expected or requested price. For volatile or low-liquidity altcoins, slippage can exceed 10% of the anticipated price. Positive slippage can happen if the price decreases during a buy order or increases while executing a sell order.

To mitigate the effects of negative slippage, traders can break down large orders into smaller portions, account for transaction fees, and utilize limit orders. These orders guarantee that traders secure their desired price or better when executing trades, effectively eliminating negative slippage.

Final Thoughts

Understanding the bid-ask spread and slippage is crucial when engaging in algorithmic cryptocurrency trading. A strategy that may look good on paper, could lose its edge on the live market if the factors like the bid-ask spread are not accounted for.

To further enhance your trading experience, consider using an algorithmic cryptocurrency trading platform, which can help you make informed decisions in the ever-evolving crypto landscape.