Drixx Academy/Mastering the Art of Trading Cryptocurrencies - Bid-Ask prices, Order Books and Slippage Explained /

Mastering the Art of Trading Cryptocurrencies - Bid-Ask prices, Order Books and Slippage Explained

Edwin Munyui
Content
April 7, 2021

Drixx Mastering the Art of Trading Cryptocurrencies - Auction Ask/Bid on Exchanges

The cryptocurrency market is slowly growing into a more diverse ecosystem - it now features opportunities for all sorts of investors. As of press time, the total market cap is well over $1.9 trillion with Bitcoin still leading the pack. This increased activity in the crypto market has led to the emergence of traders amongst other stakeholders. Today, quite a number of people have made a career out of crypto trading - a space that has since evolved to feature derivative instruments as well.

While it may seem easy to become a crypto trader, it is an art that requires patience, resilience and sound strategy for one to become profitable. In fact, most traders rarely beat the market. For the purpose of this article, we will highlight a few of the ‘must know’ terminologies for a cryptocurrency trader. This knowledge is a fundamental building block if you are looking to start a career in crypto trading or advance your expertise.

Bid-Ask prices

When trading in the financial markets, buyers and sellers will often be involved in some sort of an auction. This means that a trader sets the price at which they want to buy or sell a particular public asset - hence the concept of bid-ask prices.

In the crypto market, setting a bid price is equivalent to stating the price at which you want to buy a given token. Traders on the buying side are the ones who normally set this price - however, it is not a guarantee that their bids will be filled. On the other hand, sellers set an ask price as a way of stating the amount they are willing to accept to sell their tokens.

For practical purposes, let’s assume we have trader A who wants to buy a particular crypto token. The price of this token is currently $1, but they anticipate that it will drop to $0.9. Trader A can set a bid price of $0.9 which is simply the amount that they are willing to pay for this token. Should the token’s price drop to $0.9, trader A’s order will be filled at this price. It may also happen that the price never drops, this means that the bid order by trader A will not be filled.

Assuming trader A was on the selling side, they can leverage the ask price to make more returns in the market. In this case, the trader expects that the price of the crypto token will go up from $0.9 to $1 - they can set an ask price that is higher than the prevailing price. Trader A’s sell order will only be filled if the price goes back to $1, as per their ask price.

In summary, bid-ask prices determine a lot of factors in any financial market. They are the key indicators of demand and supply dynamics - a lot of bids means that the buying pressure is high and could push the price higher. As for the ask prices, increased selling activity is likely to push the price down and vice versa.

Order Book

An order book is an electronic record system where the unfilled bid-ask prices are listed. It features both buying and selling orders that are pending (target prices set by the traders are yet to be triggered for execution). Most traditional exchanges use order books for the daily market activity - this applies to crypto as well.

So, how exactly does a crypto exchange order book work? It is as simple as understanding the bid-ask price dynamics. Crypto exchange order books record open bids and asks - this information can be used by traders to interpret the market. In fact, some of the experienced traders use the order book to predict whether the market will move upwards, downwards or range sideways.

It is quite noteworthy that order books feature more information about the buy and sell orders. Some crypto exchange order books include the quantity, market depth and the spread (difference) between bid-ask prices. That said, let’s highlight some examples to better explain how order books work in the cryptocurrency market.

BTC-USD order book (Example)

Drixx BTC-USD ask-bid order book Example.jpg

In this case, we have a BTC-USD order book that represents unfilled orders by both buyers and sellers. As previously highlighted, these orders can only be filled if there is a matching counter offer where both the buyer and seller agree on the price.

Going by this specific example, we can see that the first sell order at $57,500 was not filled since there is no matching bid at that price - this goes for the second and third sell orders too. Assuming another trader placed a bid of 160 units at $57,500, this would have been filled by matching it with the three ask orders.

The exchange would have first filled 10 units at $55,400, followed by 50 units at $56,000 and finally 100 units at $57,500. Notably, exchanges fill orders starting with the best price on offer - a trader can buy or sell tokens at a better price than they anticipated. This is just a simple overview of the order book, you can learn more about the different types of orders on Drixx academy.

You might also want to read about DeFi AMMs (Automatic Market Makers) which effectively function as automated, decentralized order books.

Slippage

Slippage occurs when orders are filled at a different price compared to what a trader had anticipated - this happens because of the market movements between the time a market order is placed and when it is actually filled. Both traditional and crypto markets experience slippage, although the latter is more prone due to high volatility and low market liquidity in some instances.

While it may seem like a bad thing, slippage can be a blessing in disguise depending on whether the executed price is more favorable than the trader’s target price. A crypto trader who is looking to enter a long position (buy/expect that the price is going up) can experience positive or negative slippage, should the market move when their order is being executed.

Positive slippage means that their order is executed at a lower price than the actual bid price while negative slippage implies that it was executed at a higher price. Clearly, the former outcome is more preferable since the trader will have bought their tokens at a bargain. The opposite applies for sell orders where positive slippage means that a sell order has been filled at a higher price and negative slippage shows that it was filled at a lower price.

Slippage can be costly to traders in any financial market - most players often use limit orders instead of market orders to completely eliminate or reduce this inefficiency. Alternatively, they have an option to set their slippage tolerance to levels they can accommodate. Decentralized exchanges such as Uniswap have flexible tolerance limits that can be set in percentages - the default is normally at 0.5%.

However, you should note that the slippage tolerance can be a double-edge cutting sword. On one hand it protects traders from market volatility while on the other it might result in missing execution opportunities. The latter is especially true for low tolerance levels. A high slippage tolerance is not that good either, in fact one can easily fall victim of front-running. Summary Mastering the art of crypto trading is important for anyone looking to debut or expand their careers in this field. The simple terminologies featured here are just but the starting point - there is more knowledge required to be a professional crypto trader. Drixx academy is one of the places where you can sharpen your skills while leveraging our yield aggregator and derivatives exchange to invest and trade in the crypto market real-time.