In every market there is a conclusion of transactions, whether it be currency, commodity or stock. They can happen either immediately or after a certain amount of time. It is on this basis (the time of the actual delivery of securities, currency or goods) that the market is divided into separate segments: urgent (forward) and spot (cash).
Spot market: what is it in simple words
spot market implies the presence of financial instruments or goods, the sale of which is carried out for cash, and their delivery occurs immediately upon sale. This market is often referred to as the cash market or the physical market. Here, the sale of financial instruments takes place, the delivery of which occurs after the payment is made. This is where spot trading differs from futures contracts. Indeed, for the latter, the delivery of goods or financial instruments takes place over time, on an agreed date.
Today, spot trading is very common, so in this article we will try to tell everything as simply as possible.
Due to the fact that when making a transaction, property rights are transferred instantly, there is a constant dynamics of the exchange rate.
According to experts, today the price of gold in the spot market is very stable. But this situation can change at any time. For example, if there is a decline in any currency. Among other things, there are other factors that can change the cost. For example, the situation in the real estate markets. This is where the performance of the United States has a huge impact.
Traders manage to quite successfully carry out operations in the market. And this, in turn, leads to increased trading. This means that sharp price changes can occur, for example, for precious metals. According to analysts who operate in the market, the cost of a particular precious metal can signal the state of the economy. There is an opportunity to make predictions about the price.
The most popular type of such a market can be considered “Forex”. This format is gaining popularity in the Russian Federation. Exist spot oil marketcurrencies, precious metals, etc.
What is a spot trade
With the question what means spot market figured it out. Now let’s talk about the spot trade. In another way, it is also called a spot contract.
The first step is to figure out what the word “spot” means in general. This is the name of the form of settlement in transactions, when the payment of the result must take place immediately. That is, there will be no delays, contracts for the cost and debt agreements. Goods received – money paid. This is how the market works.
The price at which the transaction is carried out is the spot price. The spot price is the current value of an asset in the market. That is, when a spot transaction is used (the asset) must be available. This spot and futures market are different. Although it is important to consider the type of asset.
For example, when currency transactions are performed, there is speculation, the purchased currency is often put up for sale immediately. As you know, all transactions and payments are carried out in electronic format, so the asset may still be in the hands of the buyer for some time.
Types of spot transactions
Although payment for spot transactions is carried out immediately, there are some types that provide for a deferred payment. In such situations, the date on which the funds for the transaction must be credited is called the value date.
There are the following payment methods:
- TOD, in which payment is made on the same day that the transaction was concluded;
- TOM, in which payment must be made the next day;
- SPT (second name T+2), in which payment is made 2 business days after the contract was concluded.
Traders have the opportunity to choose any of these types.
Features of trading in the spot market
It has probably already become clear to many that such trading platforms are speculative. Therefore, those traders who decide to try themselves in this type of earnings need to be prepared for the risk.
Spot market contracts can be deliverable (in which a real asset is delivered at the end of the transaction) and non-deliverable (in which transactions are settled and the asset does not become the property of the buyer).
The most common type is non-deliverable. And it is not surprising, because otherwise the brokers would have incurred considerable losses. And here they can earn on spreads.
It is possible to carry out transactions for the purchase / sale of an asset and settlements on them within two business days. Also, there is a high degree of asset volatility in comparison with the derivatives market. This is due to the fact that pricing in the spot market depends on the ratio of supply and demand for an asset.
Also, the spot market is characterized by:
- no interest rate on the price of the delivered asset;
- fixed exchange rates and other assets.
Among other things, most of the transactions are carried out electronically with confirmation of transactions using electronic notifications.
How the spot market works
In the spot market, the sale of financial instruments or commodities is carried out using cash. Their delivery takes place at the time of sale. It is not uncommon to see the spot market referred to as the cash market or the physical market. This is where the trading of financial instruments and goods takes place, and their delivery takes place after the payment has been made.
If we talk about futures contracts, they differ significantly from spot trading. After all, the date of the sale is first agreed there, and then, after a while, the transaction takes place. What is the working principle of the spot market? They are public financial markets. Here, cash is exchanged for assets, commodities or other financial instruments.
In most cases in the spot markets, the transfer of funds between buyers and sellers may not take place at the time of the transaction, but both must agree to the transaction right at that moment.
In general, a futures contract is not a spot transaction. After all, here the delivery of underlying assets occurs strictly on an agreed date in the future. However, there are some exceptions. When a futures contract expires, it can be called a spot transaction. Only in this case, the buyer and seller must exchange cash for an asset.
Pros and cons of the spot market
Of course, the spot market, like any other, has its positives and negatives. To decide whether this type of trading suits you or not, you need to understand this in more detail.
The disadvantages include:
- cheaper cost in comparison with the derivatives market;
- volatility, which allows speculators to earn money;
- high liquidity, which appears due to the instant execution of contracts.
The disadvantages include:
- large leverage that increases risks;
- the possibility of sliding prices at the peak of volatility, which can bring considerable losses for traders.
Also, there is no state reaction to the market in the spot markets, here all the risks lie with the traders themselves. Starting trading on the spot market, you need to take into account all the risks. And there are a lot of them.
What types of markets are
Markets fall into two categories:
We have dealt with the spot market. Now a little about the urgent.
Urgent does not mean fast. It got its name because of the word “term”. That is, it means that transactions have a deferred expiration date. This is convenient in cases where the buyer needs to fix the cost and protect himself from its growth. And the seller, in turn, will receive a guarantee that his goods will be sold.
However, now the futures market is too speculative. Traders realized that with delayed deliveries, assets could not be purchased at all. But there is a great opportunity to buy and sell derivative assets. They are called derivatives. Now it is not even required that the asset be available, you only need to pay a deposit.
Although the spot market is considered not the place where you can speculate, traders began to use both the futures and the spot market to hedge (balance) risks. For example, one and the same person can purchase shares on the spot market and at the same time enter into a forward contract on them.
The whole market is guided by the spot price. And this means that when working with any kind of assets, they are subject to constant monitoring.
It is also important to remember the following points:
- when selling or buying securities and when paying for them at the same moment, this will apply to a transaction in the physical market;
- contracts that have been sold or bought on the spot market become effective immediately;
- The physical market differs from the futures market in that funds are exchanged immediately.
Also, ownership of securities or other instruments occurs immediately.
The materials presented in this section do not constitute individual investment advice.