What does "Bid-Ask Spread" and "Slippage" mean?

Slippage is a result of the quantity and volatility of an asset you want to trade. Having a basic understanding of an exchange's order book will help you avoid any surprises.

What is Bid-Ask Spread and slippage

When you buy and sell crypto assets on a cryptocurrency exchange, the market prices are directly correlated with supply and demand. In addition to the price, there are other crucial aspects to take into account, such as trading volume, market liquidity, and order kinds. Depending on the state of the market and the order types you use, you won't always get the price you want for a transaction.

Because market participants are always haggling, there is a spread between the two sides (bid-ask spread). Slippage is a result of the quantity and volatility of an asset you want to trade. Having a basic understanding of an exchange's order book will help you avoid any surprises.

What is Bid-Ask Spread?

The difference between the highest bid and lowest ask prices in an order book is known as the bid-ask spread. The Bid-Ask Spread is frequently created by market makers or broker liquidity providers in traditional markets. The variation between limit orders from market players determines the spread in crypto marketplaces.

If you want to acquire anything at the current market price, accept the vendor's lowest requested price. You will accept a bidder's highest offer if you need to sell anything immediately away. Higher liquidity assets have a lower bid-ask spread than low liquidity assets, suggesting that buyers and sellers can execute their orders without causing significant price changes. This is the effect of the order book having a large number of orders. When closing large volumes of orders, a bigger bid-ask spread will cause larger price movements.

Bid-Ask Spread and Market Makers

A key concept in financial markets is liquidity. One could have to wait several hours or even days for another trader to match their order while dealing in low-quality markets.

Although individual traders' liquidity is essential for generating liquidity, not all markets have enough of it. In traditional markets, brokers and market makers, for instance, provide liquidity in exchange for arbitrage profits.

By simultaneously buying and selling an asset on a market, a trader can profit from the bid-ask spread. They can also profit from the spread by continuously selling at the higher ask price and executing buy orders at the lower bid price. Even a little spread could generate substantial gains when traded in massive volumes throughout the day. High demand assets start to experience a lower spread as market makers compete to reduce it.

Depth charts and bid-ask spread

Let's examine some examples from the cryptocurrency market to see how volume, liquidity, and bid-ask spread are related.

An asset's order book is depicted graphically in the [Depth] option. Bid quantity and price are displayed in green, and ask quantity and price are displayed in red. The bid-ask spread, which can be calculated by taking the red ask price and subtraction from it the green bid price, is the space between these two locations.

Liquidity and narrower bid-ask spreads are impliedly related, as we have said. Since trading volume frequently serves as a proxy for liquidity, we anticipate larger volumes and lower bid-ask spreads as a proportion of asset price. The competition between traders looking to profit from the bid-ask spread is much greater for highly traded stocks, cryptocurrencies, and other financial instruments.

Bid-ask spread percentage

We must calculate the bid-ask spread in percentage terms in order to compare it across various cryptocurrencies or assets. It's easy to calculate:

(Ask Price - Bid Price)/Ask Price x 100 = BidAsk Spread Percentage

What is slippage?

Slippage is frequent in markets with high volatility or little liquidity. Slippage occurs when an order is made because the exchange tries to match your buy or sell request with the limit orders in the order book. The order book will use all reasonable efforts to fill your order as cheaply as feasible. The order book will shift up the order chain to the next best price if there isn't enough volume at the price you desire. Your order could ultimately be executed at a cheaper price than you anticipated.

If you decide to purchase 1,000 units of an asset now selling at Rs. 100 but the exchange is short on liquidity, your final rate would be different. You will need to accept orders beyond your maximum bid price of Rs. 100 until the transaction is finished. Your average transaction price will surpass the Rs. 100 target as a consequence.

Positive Slippage

Slippage does not necessarily result in you paying more than you wanted to. Positive slippage is the phenomena in which a price increases while a sale order is being filled or decreases while a purchase order is being filled. Positive slippage is rare but possible in some extremely turbulent markets.

Negative Slippage

Negative slippage is a major issue for all traders. When an asset's price increases after you make a buy order or decreases after you put a sell order, this is known as negative slippage.

How To minimize Slippage?

Slippage is inevitable when trying to quickly execute orders in a fast-moving trading environment. However, the following steps will help you minimise negative slippage:

Split your orders – Instead of attempting to complete a huge order all at once, divide it into smaller halves. To spread out your orders and prevent sending in orders that are too big for the available volume, keep a constant check on the order book.

Use limit orders – These make sure you receive the purchase or ask price you anticipate or perhaps higher. Limit orders aren't always executed quickly, and you risk missing some transactions if you set your tolerance threshold too low. They do, however, promise that you won't suffer any unintended repercussions.

Conclusion

Trading cryptocurrencies has the potential to be very profitable, but it can also be risky. The bid-ask spread and slippage both have the potential to result in trading losses in addition to the inherent market volatility. Even though you might not always be able to avoid them, it's crucial to take them into account when choosing which trades to make. This is particularly true for high-volume deals, when it is possible that the average price per cryptocurrency will turn out to be higher or lower than expected.

Although financial markets are intended to offer traders a wide range of trading alternatives, market participants still choose whether slippage occurs and how much it impacts them. In order to maximise trading profits, traders must pay close attention to and take into account liquidity limits.

Density is offering 10 USDT for first time traders upon completing their KYC and Bank verification. You can trade for free, don't miss out on this opportunity. Please do contact us on whatsapp +91 90350 92634 for any queries you have.

You can learn more about the blockchain industry at our Density Blogs.