What is Slippage?
Slippage describes the difference in the level of the final price of a trade vs. where the market was at the time of execution. This could be on a live pricing whereby you simply want to execute at best, or if you are working a stop order and it is triggered. These differences between the prices you see on screen or your stop levels, and your final prices are determined by liquidity and order depth.
There are varying degrees of liquidity - the volume of lots traded - between the base metals. Copper and aluminum for example are extremely liquid contracts, compared to metals like tin, steel, lithium, and cobalt which see drastically lower volumes traded daily. The metal you are trading will heavily influence how far away from a screen price or stop level your final price will be. The lower the liquidity for that metal, the larger the slippage you can expect.
The exact amount of slippage you face will be determined by the order depth for that commodity. There is a finite number of lots that you are able to buy or sell at any given bid or offered price. This is known as order depth. For example, if there are five lots of LME 3M copper bid at $9500/mt, this means that the largest size you could sell at that price, at that exact time would be five lots. If you had an order for 10 lots that you needed to fill at market (at the best current price), you would receive 5 lots at $9500/mt, and then five lots at the next best bid. Let's say that the next best bid was $9498, and the depth was again 5 lots, your 10 lot order would be filled with a combination of 5 lots at $9500, and 5 lots at $9498, for a final price of $9499 for all 10 lots. A slippage here of $1/mt is fairly manageable. But for larger orders even on liquid contracts slippage can start to increase. And for less liquid contracts slippage can increase very quickly as the trade size increases.
This is important to understand because counterparties will often be watching the screen price, and expect to be filled for any amount of volume at that bid or offered price, regardless of the order depth available. To avoid confusion, you need to be able to explain to them why they aren't necessarily receiving that exact price they see on-screen.
The same situation can occur on stop orders. Let's say you are working a 40-lot copper order at $9500/mt. You watch as the market crashes through your stop level all the way down to $9475 in the blink of an eye, but you are feeling secure with your stop at $9500. However, your broker calls you to let you know your fill on the stop was $9488/mt, a slippage of $12/mt. Aside from being annoyed and threatening to find another broker, you instead need to know that stop levels are not guaranteed. There is a queue system used to place orders. Your 40 lots may be behind another 40 lots at $9500, and by the time they were filled, the order depth had changed to reflect the falling market and there were no longer any bids at $9500. In fact the next best bid was now $9495, which is where your stop started to be filled. This would have continued until all 40 of your lots were filled, giving you the final price of $9488/mt. A side note here, if you are overly concerned about slippage I would tend to avoid placing stop orders at large round numbers (hundreds or thousands) as they are often support or resistance points so your order could be at the back of a long queue. And when these levels break they tend to break hard and slippage can be substantially worse.
That same counterparty who was complaining about their fill at market is likely to be even more frustrated when you tell them their stop cost an additional $12/mt. Having proactive conversations with counterparties before they place or execute orders saves a lot of annoyance (on your part and theirs) further down the line. And if you’re facing enormous levels of slippage regularly, then maybe you do need a new broker. If this is the case give me a call, and I will happily put you in touch with the more reliable and honest brokers, not the ones trying to gauge your eyes out on every fill.
