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Spot Trade

Updated on May 30, 2024
Article byPrakhar Gajendrakar
Edited byAaron Crowe
Reviewed byDheeraj Vaidya, CFA, FRM

What is Spot Trade?

Spot trades are immediate transactions that involve the trading of commodities and financial instruments. Both the payment and delivery take place on the spot. These transactions occur in spot markets. The commodities are bought at the current market price, called the spot price.

Spot markets are also known as financial markets, cash markets, or physical markets. The term physical market refers to the physical exchange and delivery of assets. In most financial markets, settlements take two working days.

Key Takeaways

  • In spot trading transactions, the payment and delivery of the securities occur immediately—at over-the-counter markets.
  •  The securities are bought at the current market price, also known as the spot price.
  •  Options and futures contracts are the opposite of spot trade, with the payment being set on a predetermined date on special prices.
  •  An investor involved in spot trade must first study the market.

Spot Trade

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Spot Trade Explained

Spot trade occurs in spot markets. Assets and commodities are bought at current market value. These transactions are immediate, and there is a physical transfer of securities. Usually, the transactions get completed within two working days—denoted as T+2 days.

Buyers and sellers determine the price through supply and demand. Spot markets encourage a transparent environment. In such trades, each transaction member is fully aware of all the prices and details.

Unlike future markets, there is no minimum capital limit for spot market transactions. At times, investors end up buying assets at an inflated price due to volatility. Later, the price declines to the fair value. It is a constant risk associated with volatile assets. In addition, there is less scope for recourse once the transaction gets completed.

Spot trades occur swiftly and in real-time; as a result, there is a lack of planning. Spot market transactions are inflexible, and parties have to handle physical delivery. In spot trade settlements, the interest rate is influenced by counterparty default risk. Therefore, investors indulging in spot trading should be ready with an investment strategy and planning. Real-time decision-making is a high-pressure situation—investors must control their emotions, else they end up with significant losses.

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Cryptocurrency Spot Trade

Binance is a spot trading platform for cryptocurrency. Traders create a Binance account and then choose a cryptocurrency pair to make a trade. Traders are not required to buy cryptocurrencies with fiat; they can exchange them for other coins and tokens on the spot. 

Types

There are two types of spot markets:

#1 – OTC Markets

Over-the-counter (OTC) initiates bilateral trades between sellers and buyers through consensus. There is no third party or a central exchange institution to regulate the trade. As a result, traded assets may not be standardized in terms of quantity price, as is the norm with organized exchanges.

In OTC markets, buyers and sellers bargain on all terms of trade and settle the transaction on the spot. These trades occur privately—OTC prices do not get published.

The currency exchange market is the most active OTC market. A foreign exchange spot transaction is known as an FX spot. Two parties enter an agreement to exchange currencies at a specified price on the spot date. The exchange rate for the FX spot is called the spot exchange rate.

 #2 – Markets Exchanges

In market exchange, buyers bid on financial instruments offered by sellers. Trading is facilitated by an electronic trading platform or a trading floor. This upgrade has made trading more efficient—instant price determination.

Some exchanges deal with a particular niche and specific types of assets. Exchange brokers (market makers) formulate trading. At an exchange, all the traded assets are standardized.

Usually, there is a minimum contract price for traded assets. Spot prices can change every minute or even within milliseconds.

NYSE and NASDAQ are global market exchanges located in the US. Other examples include The London Stock Exchange (LSE), The Hong Kong Stock Exchange (HKSE), and The Shanghai Stock Exchange (SSE).

Examples

Let us look at some examples to understand the practical application of spot trading.

Example #1

In December 2020, spot markets moved slowly—the flatling of oil futures put the brakes on buying. However, almost 20 Angolan Cargoes were made available in January. Many IOC (Indian Oil Corporation) tenders closed within a week. Unipec bought a cargo of Djeno and IOC issued a tender for cargo in January. Sasol from South Africa came forward with a buy tender for February arrivals. At the same time, Perenco and SNH offered two Cameroonian Kole crude cargos through a closing tender.

Example #2

Spot prices rose for hot-rolled coil in China’s domestic and export markets after ferrous futures prices made a bull run across the board. It stemmed losses caused by Chinese regulators—who tried to stabilize iron ore prices. However, spot HRC prices declined for two days in Eastern China before the spike occurred.

 Frequently Asked Questions (FAQs)

What is a spot trade example?

The transaction takes place immediately. So, in a way, a supermarket purchase can be used as an analogy—when a person goes to a supermarket to buy a product, they pay for it and almost immediately receive the product. Spot markets operate in a similar manner.

Can spot trade make money?

It is like any other transaction in the financial market. There is only one difference— the whole process occurs immediately with a physical exchange of assets. Therefore, there is no real proof of whether it can make investor money or not.

Why is it called spot trading?

It is called spot trading because the transactions take place on the spot. Therefore, there is no delay in payment or delivery. But for settlement, it usually takes two working days from the day the trade was initiated.

This has been a Guide to What is Spot Trade and its Meaning. Here we discuss spot trade transactions, examples, fx spot, cryptocurrency trades, spot traders, and spot trade vs. futures. You may also have a look at the following articles to learn more –

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