While investing in cryptocurrency, market values fluctuate owing to a variety of factors. Market liquidity, trading volume, and order types are all significant aspects to examine in addition to an asset’s price. Because of these several considerations, you may not always be able to achieve the trade price you desire. Therefore, it is essential to know about bid-ask and slippage before you trade.
What is a Bid-Ask Spread, and how does it work?
The bid-ask spread is the gap between the maximum ‘bid’ price and the minimum ‘ask’ price for an asset. This isn’t specific to the cryptocurrency market; market makers and broker liquidity providers establish a bid-ask spread in traditional markets. The spread in crypto markets is generated by the differential limit orders between buyers’ and sellers’.
- The lower the bid-ask spread, the stronger the liquidity of an item; a vast quantity of orders and a slight bid-ask spread characterise more liquid assets.
- When placing big volume orders on an item with a greater bid-ask spread, there will be significant price fluctuations.
- When making an instantaneous market price acquisition, you must accept the least asked price from the vendor. It is critical to evaluate the highest bid price if you just want to make an instant transaction.
Bid-ask spreads and market makers
In the financial markets, asset liquidity is critical. In low-liquidity marketplaces, you may have to wait a lengthy period for another trader to match your order. The capability of a market to allow assets to exchange rapidly and readily is known as liquidity. Liquidity creation is crucial, but individual traders cannot provide enough liquidity for markets.
- In traditional markets, market makers and brokers supply liquidity for arbitrage profits. Market makers capitalise from the bid-ask spread by simultaneously purchasing and selling an asset. They repeatedly buy the items at a low bid price and sell them at a higher asking price, profiting from the bid-ask spread.
- If the spread is minimal, trading in big volumes throughout the day will result in significant profits. Because market makers fight and lower the spread, commodities in the high competition have lower spreads.
Bid-Ask spread and depth charts
Explore real-world markets to understand better the relationship between liquidity, trade volume, and the bid-ask spread. In exchange platforms, you may simply view the bid-ask spread by choosing the depth chart option.
On crypto exchanges, the depth option displays a graphical presentation of an asset’s order book. The number and price of bids are green, while the number and cost of asks are red. The difference between these two locations is known as the bid-ask spread. The bid-ask spread can be calculated by subtracting the green bid price out from the red ask price.
Percentage of the bid-ask spread
We may easily compare various assets and cryptocurrencies by analysing a bid-ask spread in terms of percentage. The percentage of a bid-ask spread can be computed as follows:
Bid-ask spread percentage = (Ask price – Bid price) / Ask price * 100
Assets having a lower percentage of bid-ask spread seem to be more prone to be liquid. When placing big market orders, choosing an item with a lower bid-ask spread percentage minimises the risk of paying unexpected prices.
What actually is slippage, and how does it affect you?
When a trade closes for a specific price than what was requested, this is known as slippage. The price may be better or lower than expected. Slippage is most common in markets with limited liquidity and intense volatility.
In automated market makers and decentralised exchanges, slippage is indeed a typical occurrence. Slippage might be as much as 10% of the expected or requested price for low liquidity or volatile cryptocurrencies.
Slippage does not necessarily result in a higher price than intended. Positive slippage occurs when the price falls while you are placing an order in pretty volatile markets. If there is positive slippage, you will get a better price when buying or selling than you asked for.
Tolerance for slippage
Some exchanges include the option to select a slippage tolerance. This feature restricts any potential slippage when trading.
It may take quite a long time to complete if your slippage tolerance is set too low. If you set this too large, bot or another trader could take advantage of your pending order and beat you to it. To buy the asset initially, front-runners frequently establish a higher price. Then, depending on your slippage tolerance, they offer it to you at the maximum price you’re willing to pay.
Negative slippage prevention strategies
Negative slippage is impossible to eliminate. The following tactics, on the other hand, will assist you in minimising it.
- Dividing your huge order into smaller bits is a good idea. Keep an eye on the order book and space out the charges.
- Consider transaction fees when you’re using a decentralised exchange. So, to avoid slippage, some networks charge hefty fees focusing on the blockchain’s traffic.
- Trade low volatility and high liquidity markets: Active participants on both sides will implement the trade at the specified price in high-liquid marketplaces. Price changes occur as a result of high volatility, and you might just encounter unforeseen expenses.
The bid-ask spread and slippage can affect the ultimate price of your trade. It may be impossible to avoid them, but they are worth considering while making judgments. The effect may be minor for small transactions, but the average price may be higher or lower than predicted for large volume trades.
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