Slippage and Liquidity
Buying the same 2,000 shares can cost very different prices in a popular stock and a thinly traded one. Compare two order books to see why.
Every lesson has an interactive simulation you can drag and play, plus a quick quiz. Sign up free to use them and save your progress automatically. Here is the text version of this lesson.
Not sure yet? Try the first lesson (no sign-up needed)「Reading the Order Book」。
Text version · Stock Trading: Next Steps, lesson 4: “Slippage and Liquidity”
Buying the same 2,000 shares can cost very different prices in a popular stock and a thinly traded one. Compare two order books to see why.
A big order eats up level by level
A market order eats the lowest ask first, then moves on to the next, pricier level. However much the average fill exceeds the price you expected is the slippage.
The deeper the book, the less slippage
The more orders at each level, the better the liquidity, and the same order only needs to eat a level or two. When the book is thin, one big order can push the price far away.
Three ways to control slippage
① Use a limit order to cap the fill price; ② split a big order into several small ones and fill them in batches; ③ avoid the open and major news, when the book is thinnest. The cost: fills may be slow, or incomplete.
Key takeaways
- Slippage = the gap between your actual average fill price and the best price you saw when you placed the order.
- The deeper the book (the better the liquidity), the less slippage the same order causes.
- Splitting orders, using limit orders and avoiding the open and major news releases all help control slippage.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Keep 2,000 shares and click "Submit market buys together": which stock has less slippage? How much more did the thinly traded one cost?
- Drag the order size to 300 shares and submit again: is there still a clear difference between the two?
- Check "Use a limit order instead (max $100.15)" and submit: how many shares of the thinly traded stock filled, and how many are still queued?
- Look at the curve below: as the order grows, how does the gap between the two lines change?
Quiz and explanations
- 1. Buying the same 2,000 shares, which stock gives less slippage?
- Answer: A popular stock with a deep book.The more resting orders there are, the harder it is to push the price away.
- 2. Which approach reduces slippage?
- Answer: Splitting the order or using a limit order.A limit order caps the fill price, and splitting reduces the one-off impact.
- 3. When you place the order the lowest ask is $20.00. You buy 1,000 shares with a market order and your average fill is $20.03. What's your total slippage cost?
- Answer: $30.You pay $0.03 more per share, $30 across 1,000 shares.
Terms in this lesson
- limit order (Limit Order): An order that only fills at your price or better: the price is guaranteed, the fill isn't.
- liquidity (Liquidity): How many orders are waiting near a price; the deeper the book, the harder it is to move the price.
- market order (Market Order): An order that fills right away at whatever price is available: the fill is guaranteed, the price isn't.
- slippage (Slippage): The difference between the price you expected and your actual average fill, which happens when a large market order eats through several price levels.