In trading, one often overlooked yet crucial factor is slippage. Slippage refers to the difference between the expected price of a trade and the actual price at which it gets executed. For traders in the Indian stock market, understanding slippage and its impact on strategy performance is essential for success.
What is Slippage?
Slippage occurs when the price of a stock changes between the time you place an order and when it is executed. It happens in fast-moving markets or when liquidity is low, leading to a gap between the expected and actual price. Slippage can affect your entry or exit price in trades involving stocks like Nifty 50 constituents, Bank Nifty, or large-cap companies such as Reliance Industries and TCS.
For example, if you place a market order to buy shares of HDFC Bank at ₹1,753 but the order is executed at ₹1,765 due to market movement, you’ve experienced slippage. Similarly, if you sell a position and get a lower price than expected, you face negative slippage.
Types of Slippage
Negative Slippage:
• Occurs when the trade is executed at a price worse than anticipated. For example, if you intend to buy ICICI Bank at ₹1,306 but the trade gets executed at ₹1,325, this is negative slippage.
Positive Slippage:
• Positive slippage happens when you get a better price than expected. For instance, if you place a sell order for Infosys shares at ₹1,903 but it gets executed at ₹1,910, you’ve experienced positive slippage.
Causes of Slippage in Indian Markets
1. Market Orders:
• Using market orders during volatile trading hours (like the opening session of the Nifty 50 or during corporate earnings announcements) can lead to slippage. Market orders prioritize speed over price, increasing the likelihood of slippage.
2. Low Liquidity:
• In less liquid stocks, such as mid-cap or small-cap stocks like Aarti Industries or Canara Bank, the lack of buyers or sellers at a specific price can cause slippage, especially for large orders.
3. News Events:
• Significant announcements from the Reserve Bank of India (RBI) regarding interest rates or government policy updates (e.g., Union Budget or GST announcements) can increase volatility, leading to price fluctuations and slippage.
4. Bid-Ask Spread:
• In stocks with a large bid-ask spread, like some illiquid small caps or even certain derivatives, slippage can occur as the available prices for buying and selling are far apart.
The Impact of Slippage on Trading Strategy Performance in India
Reduced Profit Margins:
Slippage directly affects your profit margins. For traders working with tight spreads or frequent trades, such as intraday traders in the Bank Nifty, negative slippage can quickly erode profits. For example, if your strategy aims to capture a ₹10 move in Nifty 50, but you face ₹5 slippage on each trade, your effective profit is halved.
Increased Risk:
Slippage can increase your overall risk, particularly if you use stop-loss orders. Imagine you place a stop-loss order for TCS at ₹4,305, but the price rapidly gaps down and the trade executes at ₹4,280. This greater-than-expected loss distorts your risk management and can create unexpected losses.
Distorted Backtest Results:
Most backtesting platforms do not factor in slippage accurately. If you’re backtesting a trading strategy on Nifty 50 (currently at ₹2,675) or Bank Nifty (₹53,384) and the system assumes all trades are executed at perfect prices, the backtest may overestimate profitability. For example, a strategy that appears to make consistent ₹5 per trade might underperform in real-time due to slippage, leading to break-even or even losses.
Impact on Stop-Loss Orders:
Slippage can render stop-loss orders less effective. In fast-moving markets, such as during Nifty expiry days, the final price at which your stop-loss is triggered may be significantly worse than anticipated. A stop-loss placed at ₹2,675 on Nifty might be filled at ₹2,650 due to rapid movement, increasing the overall loss.
How to Minimize Slippage in Indian Markets
Use Limit Orders:
• Unlike market orders, limit orders allow you to specify the maximum or minimum price you’re willing to pay or receive. For example, if you want to buy SBI shares at ₹802, you can set a limit order at ₹802, ensuring the trade only executes at that price or better.
Trade During High Liquidity Periods:
• Slippage is more common in less liquid markets. By trading during peak hours of the Indian stock market (such as the first and last hour of market sessions), or sticking to highly liquid instruments like Nifty 50 futures or blue-chip stocks, you can minimize the impact of slippage.
Avoid Trading Around Major News Events:
• News announcements, such as RBI monetary policy updates or corporate earnings reports, can cause rapid price movements. Avoid trading just before or during these events to reduce exposure to slippage.
Reduce Trade Size:
• Smaller trade sizes reduce the risk of slippage, especially in less liquid stocks. If you’re trading a mid-cap stock like Bajaj Holdings, executing smaller trades reduces the likelihood of having to accept a less favorable price due to market liquidity.
Account for Slippage in Backtesting:
• When backtesting a trading strategy for Indian markets, it’s essential to factor in slippage. For example, if your backtesting software shows a hypothetical profit of ₹10 per trade in Nifty futures, consider incorporating 1-2 points of slippage to reflect real market conditions.
Slippage is an unavoidable reality of trading, especially in volatile or less liquid markets. However, understanding how slippage impacts your trades and implementing strategies to minimize it is critical for long-term profitability. Whether you’re trading the Nifty 50, Bank Nifty, or individual stocks like Reliance, TCS, HDFC Bank, or Infosys, accounting for slippage in your strategy will help align backtested performance with real-world results.
