Spot trading is a simple way to invest in the market. Your first trade will likely be a spot transaction with cryptocurrency.
Spot markets have different asset classes like cryptocurrencies, shares, commodities, forex, and bonds. You might be familiar with spot markets and spot trading. Some popular exchanges like NASDAQ or NYSE (New York Stock Exchange) are spot markets. Let’s discuss the spot market, and you will be surprised by your familiarity with the spot market.
What is spot trading?
A spot market is a market where you can buy and sell assets immediately. Buyer trades assets with the seller in fiat or some other medium. Assets are delivered instantly, but it also depends on what’s being traded.
The spot market is also called cash markets because there are upfront payments. Spot markets have different forms, and third parties are called exchanges, and it facilitates trade. With over-the-counter (OTC) trades, You can directly trade with others. We will discuss it later.
Types of spot trading?
There are 2 types of spot markets:
It’s a place where buyers and sellers are trading directly, and there is no third party involved during the transaction or institution to regulate the trade. As a result, the asset traded might be below standard in terms of quantity, price, or others.
Hence, there is a negotiation between buyers and sellers before the transaction. OTC markets prices might not be published because trades in OTC markets are private, and Currency Exchange is highly active and generally known as The OTC market. A centralized exchange does not offer direct trades. The Forex( Foreign Exchange Market) is the world’s largest OTC market, and the forex market has an average daily turnover of $5 trillion.
The price is based on a spot or a future price in an OTC transaction, and terms in an OTC transaction are not standardized, and therefore, may be subjective to the choice of the buyer or seller. OTC transactions are spot trades, and futures transactions are not on the spot in spot exchanges.
We have over-the-counter trading also known as off-exchange trading. There is a direct trade of Financial assets and securities between dealers, traders, and brokers. The OTC market uses multiple ways to communicate to organize trades for spot trading and the most popular methods to communicate are phone calls and messaging.
OTC benefits by not using an order book. Slippage is caused by trading an asset with low liquidity and large order. Your order cant be filled at the price wanted, So you pay a high price to finish the order,and there are better prices for large.
If the order is too large, liquid assets like BTC can also experience slippage. So OTC trades also benefits large BTC orders
In organized market exchange, buyers and sellers meet for bidding where sellers offer financial instruments and commodities. You can execute trading on an electronic trading platform or a trading floor. Trading is more efficient now because of Electronic trading platforms, and you can determine price instantly, and some exchanges have a large number of trades.
In Exchange, you can deal in several financial instruments and commodities; Sellers might make a niche for some assets. Traders act as market makers and take part in finishing the Exchange. In Exchange, Assets traded are up to standard. Exchange standards are used to check the quality of the assets before the trade.
There is a minimum contract price for assets traded in specific quantity and value and seller offers and buyers bid to set the price for the particular assets. Spot prices change quickly, like in some minutes or seconds and even in milliseconds.
Procedure and trading have standards and Exchange is regulated. Examples:- New York Stock Exchange (NYSE) and the Chicago Mercantile Exchange Group.
- The New York Stock Exchange (NYSE) is the best example of a spot market as the buying and selling of stocks is on the spot.
- The Chicago Mercantile Exchange(CME) is an example of a futures market where traders buy and sell futures contracts.
- Spot trading is not limited to one place. Mainly spot trading occurs on exchanges, and you can trade directly with others, and there will be no interference from a third party. These types of sales and purchases are called over-the-counter trades. Each spot market is different.
Types Of Market Exchange
- There are 2 forms of exchanges: centralized and decentralized—a centralized exchange trades in assets like cryptocurrencies, commodities and forex. The Exchange acts as a mediator between buyers and sellers of the trade assets. You should have fiat or crypto in your account if you want to trade in a centralized market.
- A proper centralized exchange should make sure that transactions execute effortlessly. Other responsibilities include maintaining regulations, fair price, KYC(Know Your Customer), security, and protecting customers. In return, the Exchange will have charges for listings, transactions, and other trade activities. That’s the reason why exchanges make a profit in both bear and bull markets; there are enough users and trading volumes.
- Decentralized Exchange is another type of Exchange, and it’s very common in cryptocurrencies. A DEX offers almost the same essential services as a centralized exchange. Still, DEXs match buys and sell orders by using blockchain technology. You don’t have to create a new account and you can trade directly without the need for transferring assets into DEX.
- Trades execute directly from the traders’ wallets through smart contracts and these codes are self-executing in the blockchain. Many users choose DEX over standard Exchange because of its privacy level and freedom. However, this comes with a con. For example, there can be a problem if you don’t have KYC and customer care support.
- Some Decentralized exchanges use an order book model. Some recent creations are Automated Market Maker (AMM) models like Uniswap and Pancakes Wap. AMMs implement a different model to determine prices and use smart contracts. To swap tokens, buyers use funds in liquidity pools. Liquidity providers charge for providing pool funds and transaction fees to use the pool funds.
Pros and Cons of spot trading
There are advantages and disadvantages to every trading strategy. There will be low risk and a confident trade if you know about the risk involved in the trade. Spot trading is really simple, but still, it has some strengths and weaknesses that we will discuss below:-
Advantages of spot markets
- Prices depend on supply and demand and prices are transparent. The future market is contrasted in this aspect as there are multiple reference prices.
- Spot trading is simple as there are simple rules, rewards, and risks. When you invest $1000 in the spot market, you can easily measure risk.
- “Buy and Forget”. In spot trading, you don’t have to worry about liquidation or margin calls, and it’s in contrast to derivatives and margin trading. You can enter and exit anytime in the market. You also don’t need to check investment regularly; short-term trades are the only time you need to check your investments regularly.
Disadvantages of spot markets
- Sometimes, spot markets leave you with assets that you can’t hold. Commodities are the best example of this. If you spot purchase assets like crude oil, you have to take physical delivery of the asset. In cryptocurrencies, You have to keep tokens and coins safe when you are holding them. On the other hand, if you trade futures derivatives, you can still get exposure to assets but settle it with cash.
- Stability is valuable for certain assets, companies, and individuals. For example, a company that wants to have its operation abroad needs access to foreign currency. It will be very unstable If the company relies on the spot market, income and expenditure planning.
- Spot trading future gains are lower than in futures or margin trading. The reason is that you can use the same amount of capital to trade in larger positions.
Why should you trade in the spot market?
Interest in the spot market can rise because:
- Trades are instant with real-time prices.
- The spot prices of assets reflect the essential market.
- There are lower spreads.
- Spot positions have no fixed expiry.
- Charting helps to conduct technical analysis.
- It’s excellent for the short term because there is no expiry on the position.
- You can trade by using leverage and open positions by using margin. But remember the profits and losses both magnify in that case.
How does the spot market work?
The spot is also called the physical market or cash market because The trades are executed quickly. At the same time, fund transfer might take time. like in the stock market T+2 and currency transactions mostly, parties want to initiate the trade on the spot.” A futures transaction is where you agree to a price now, but the Exchange will take place later.
Futures trades are about to expire contracts, and it is also known as spot trade sometimes because the contract is expiring means that the buyer and seller will exchange cash for the asset instantly.
The current price of the financial instrument is called the spot price. The spot price is the price at which you can buy and sell a financial instrument instantly. The spot price is created by posting buying and selling orders. Therefore, the spot price might change every second in the liquid market; new orders replace old orders in the market as soon as the requirement is fulfilled.
Spot originating on the spot means you can purchase an asset on the spot in the market.
Example of spot market
Let’s say an online clothing store in Switzerland offers a 40% discount to all the international customers who will pay the full amount within seven business days after placing an order.
Aubrey, who operates an online clothing business in Canada, sees the offer and decides to purchase $5,000 worth of T-shirts from the online store. Since she needs to buy Swiss Franc for quick delivery and she is happy with the current CHF /CAD exchange rate of 0.73, Aubrey initiates a foreign exchange transaction at the spot price to buy the equivalent of $5,000 in Swiss Franc, which works out to be CHF 3650. The settlement date for the spot transaction is T+2, so Aubrey receives her Swiss Franc in two days and settles her account to receive the 40% discount.
Difference between spot market and derivatives market?
Ownership of a share
You are the owner of shares, or you are termed as a shareholder as soon as you buy shares and take delivery in the cash market until you sell the shares. However, in the capital market, You can’t be a shareholder when you are trading in derivatives and the reason behind it is that you have to square off after you hold positional stocks for a while.
you can hold the shares for life after buying them from the cash market. But it is the opposite in the futures market, where you have to Liquidate the contract in three months max. Cash segments have a trans-generational share, which means you can transfer them from one generation to the other.
In the cash market, you buy shares, take delivery, and you become an owner that’s entitled to get dividends from companies. But, there is no such thing as dividends, rights share, bonus share etc., when you buy any derivatives contract.
There is risk in both cash and futures markets, but the futures markets have a higher risk because you have to liquidate a contract before a particular date, or else you will book losses. In the cash market, you can hold bought shares for an indefinite period and sell them when prices are higher.
Difference in investment objective
You buy a contract in the derivatives market to hedge risk or to speculate. In the cash segment, Individual traders that buy shares are investors.
Lots and shares:-
you buy a lot in the derivatives segment, but you buy a share in the cash segment.
You only pay the margin money in the derivatives segment. For example, if you buy 1 lot of SBI (2000 shares), then you pay 15 to 20 per cent of the cost of the 2,000 shares and not the total amount. It’s a contrast in the cash segment as you have to pay the total amount and not just margin.
Difference between spot market and futures market?
The spot market is used as the underlying asset in futures. Futures or forward is a derivative contract and These contract owners get control of the underlying in future. The price on the contract is accepted today. Delivery of commodity, financial instruments and other assets is initiated after the contracts expire, and to avoid delivery, traders will either close out their contracts or rollover. Future and Forward are the same thing, but forwards trades over-the-counter (OTC), and it is customizable while futures are traded on exchanges and futures are standardized.
Difference between spot trading and margin trading?
Margin trading is available for some spot markets, but it is not similar to spot trading. In Spot trading, you have to purchase the asset immediately. But you borrow funds from a third party with interest that helps you enter a larger margin trading position. Thus, there are significant profits because margin traders are borrowing funds. But it will also amplify the potential losses, so be careful before you lose the initial investment.
The spot market is a market where you buy or sell financial instruments on the spot. After you buy shares and take delivery, you are the owner of shares in the spot market. There are two types of spot markets over the counter and market exchange. High profits and high risk in the over the counter market and you buy and sell shares instantly, and there is instant delivery in the over the counter market. In the futures market, there are trading contracts where you agree to buy assets at a specific price for a particular time. You have to settle the futures contract before the future date or before the contract expires. In the spot market, you buy and hold for an indefinite period and sell it when there is a rise in the value of shares. The spot price is decided by the buy, and sell orders received. You don’t have to look at charts. They only do this when you are short selling or trading in the short term. Price movements are frequent in spot markets. Overall the spot market is an excellent opportunity to earn money, and you can solve the risk with TradeATF and ROinvesting as they provide safe trading.