Understanding spread and slippage: the invisible killer of Transaction Cost

Why Traders Must Follow These Two Concepts

In cryptocurrency trading, in addition to fees, there are two factors that will directly affect your actual costs - spread and slippage. Many novice traders overlook these two concepts and ultimately find that their execution prices are far below expectations. Today, we will delve into how they affect each of your trades.

What is the spread between demand and supply

In any market, buyers and sellers will never reach an agreement at the same price. Buyers want to purchase at the lowest price, while sellers want to sell at the highest price. This opposing demand creates a price difference in the order book—this is called the spread.

More specifically, the spread is the difference between the highest bid price and the lowest ask price. If you want to buy immediately, you must accept the lowest selling price; if you want to sell immediately, you must accept the highest buying price. This price difference is the cost of the market.

How is the size of the spread determined by liquidity?

In highly liquid markets, such as mainstream trading pairs, the orders from buyers and sellers are very dense, and the spread will be very narrow. Taking Bitcoin as an example, due to the huge trading volume, the spread may be only a few cents. However, for tokens with smaller trading volumes, the spread may reach several dollars, which means your actual costs will be higher.

A low liquidity market is like a narrow road, where traders need to travel a greater distance to complete a large transaction. Therefore, the more intense the competition among market participants, the smaller the spread.

How Market Makers Profit from the Spread

Market makers play a crucial role in maintaining market liquidity. They continuously buy and sell assets simultaneously, profiting by repeatedly buying at a lower price and selling at a higher price. Even if the spread for each trade is only 1 dollar, these small spreads can accumulate into significant income when they conduct thousands of trades throughout the day.

For example, a market maker might buy BNB at a price of $800 while simultaneously selling it at $801, earning a spread of $1 each time. For traders, they must accept these conditions to execute trades immediately. High-demand assets attract more market makers competing, ultimately narrowing the spread.

How to calculate the percentage of spread

To make a fair comparison between different assets, we need to express the спред in percentage. The calculation formula is quite simple:

( ask-price - bid-price ) / ask-price × 100 = spread percentage

Let's illustrate with a practical example. Suppose the ask price of a certain coin is $9.44, the bid price is $9.43, and the spread is $0.01. Calculation: $0.01 ÷ $9.44 × 100 ≈ 0.106%.

In contrast, even if the absolute value of the Bitcoin спред is $1, due to the higher price of Bitcoin, its percentage спред is only about 0.0008%. This indicates that assets with low liquidity tend to have a larger percentage спред, which completely aligns with our liquidity theory.

What is проскальзывание

Slippage is another hidden cost in trading. It occurs when you place a market order and, due to insufficient market liquidity, your order is executed at multiple worse prices.

If you want to buy a certain token at a price of $100, but there is only $50 of liquidity on the order book. The system will continue to sweep the price upward (accepting higher prices like $100.50, $101, etc.) until your entire $100 order is filled. In the end, your average execution price will be much higher than $100—that is slippage.

In highly volatile or low liquidity markets, slippage is particularly pronounced. For certain small coins, slippage may even exceed 10%, which has a severe impact on traders' profits.

The lucky moment of 正向 проскальзывание

However, slippage is not always bad news. In some cases, the market price may fluctuate in your favor when you place an order. When you place a buy order and the price drops, or a sell order and the price rises, you may actually execute at a better price than expected. This type of “positive slippage,” while rare, can occasionally occur in highly volatile markets.

Set slippage tolerance

Many exchanges allow you to manually set the acceptable slippage range. Some automated market maker platforms offer this feature, letting the system know you are willing to execute trades within a deviation range of X%.

Setting a lower tolerance means that orders may take longer to execute, and in some cases, may not be executed at all. Setting a tolerance that is too high may expose you to the risk of front-running—other traders or bots may pay higher gas fees to complete the transaction first and then resell to you at the optimal price, pocketing the difference.

How to Minimize Trading Costs

Although it is impossible to completely avoid spread and slippage, there are several ways to significantly reduce the risk:

1. Split large orders

Rather than submitting a large order all at once, it's better to break it down into several smaller chunks. Carefully observe the depth of the order book to ensure that the size of each small order does not exceed the available liquidity at that price level.

2. Choose a high liquidity market

Always prioritize trading high liquidity assets and trading pairs. Low liquidity markets can significantly affect your execution price and may even eat into your expected profits.

3. Use limit orders instead of market orders

A limit order is executed only at your specified price or a better price. Although it requires waiting, it can completely avoid negative slippage. This is the most direct way to mitigate risk.

4. follow on-chain costs

If you use a decentralized trading platform, be sure to factor in gas fees. During times of network congestion, these fees can be shockingly high, enough to offset any trading profits.

5. Timely grasp of market depth

Before placing an order, check the depth chart of the order book. If you find that the liquidity at a certain price level is extremely thin, you should reevaluate whether it is worth trading at this time.

Summary

Spread and slippage are often overlooked but have far-reaching effects in cryptocurrency trading. For small orders, these costs may seem insignificant, but when you make large transactions, a difference of a few percentage points can result in significant capital loss.

Understanding these two concepts is a must for any serious trader. Especially in the decentralized finance space, a lack of foundational knowledge can land you in the traps of front-running or slippage. Before placing your next order, take a second to think about спред and проскальзывание—this small habit could save you thousands of dollars.