What is Spot Trading?

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Spot trading is one of the most fundamental things you need to be aware of before you start trading in the financial markets. If you are already a trader or an investor, you may have practised this kind of trading without being aware of it. After all, it’s the most common way to participate in the markets. In this article, we’ll delve deeper into the meaning of spot trading, see how it works and discuss its advantages and limitations.

Also Read: Have Knowledge of What Bullion Trading Means

What is Spot Trading?

Spot trading is the process of buying or selling assets in the financial markets immediately or on the spot (hence the name). The transaction occurs at the prevailing market price, which is also known as the spot price. 

Buyers in the spot market take delivery of the asset immediately, while sellers relinquish their rights to the asset on the spot. To put it simply, spot trading occurs in the moment — with no need to wait for several trading sessions to complete or square off a transaction. 

In India, you can trade in different segments of the spot market such as:

  • Shares or stock market
  • Commodities market
  • Forex or currency market
  • Indices in the stock market
  • Exchange-Traded Funds (ETFs) in the financial market

Also Read: What Is Margin Trading in the Forex Market

How Does Spot Trading Work?

Now that you know the meaning of spot trading, let’s take a closer look at how it works. The current market price in spot trading is determined by various factors like demand and supply, company-specific parameters and broad economic drivers. The spot price is typically transparent and easily visible to all traders, thus facilitating unambiguous trades. 

When you buy assets via spot trading, you have to pay the entire value of the assets being traded. Similarly, when you sell assets through a spot trade, the entire value of the assets being sold will be credited to your trading account. 

In essence, when you want to trade in the spot market, there are three key components in play, as outlined below:

  • Spot Price

This is the current market price at which your buy or sell order will be executed in spot trading. You need to keep an eye on these prices since they may fluctuate greatly in volatile markets. 

  • Trade Date

The trade date, represented as ‘T’, is the date on which you place your buy or sell order in the spot market. 

  • Settlement Date

The settlement date is the date on which your trades are settled. As of September 2023, the settlement date is T+1. This means spot trades are settled on the day after the trade occurred. 

Types of Spot Markets

Spot trading is supported in two types of spot markets — over-the-counter (OTC) and exchange markets. Let’s look at these markets in more detail.

  • Over-the-Counter Markets

In OTC markets, spot trading occurs between two trades via mutual consensus about the price and quantity of the assets to be traded. There is no regulator, middleman or third-party entity to regulate or facilitate the trades here. 

  • Exchange Markets

You may be familiar with spot trading in the exchange markets, which occurs via established exchanges like the NSE, BSE, NCDEX and more. These exchanges facilitate electronic trading that makes it easier to track spot prices and execute spot trades almost instantly.

The Other Side of the Coin: Forwards and Futures

Now that you know what spot trading is, let’s look at what it is not. Spot trading is different from trading in futures and forward contracts. In a spot trade, you take (or give) immediate delivery of the asset. However, in futures trading, you do not own the underlying asset at all. Instead, you only buy or sell a contract that derives its value from the underlying asset. 

You can use leverage to trade in large volumes of assets without any significant initial outlay. However, the risk is higher in the futures market than in the spot market because unfavourable market movements could lead to larger losses. 

Advantages and Disadvantages of Spot Trading

Like every trading strategy, spot trading also has some unique advantages and disadvantages. You must be aware of these pros and cons before you attempt to trade in the spot market. 

The advantages of spot trading include the following:

  • There is greater transparency in the spot market
  • Trades can confidently execute spot trades knowing exactly what the outflow or inflow will be
  • You can hold on to your assets if the spot price is not favourable

The limitations of spot trading include the following:

  • It is not easy to hedge your position in times of market volatility without venturing into other market segments
  • It is harder to plan spot trades in a volatile market
  • The initial outlay may be huge if you are going long in the spot market

Also Read: Be Aware of Buy and Hold strategy in the Stock Market

Conclusion

As a beginner, spot trading may be the easiest way for you to participate in the financial markets. Once you gain a bit of experience, you can venture beyond the spot market into the futures or options market and other segments. However, the universal rule to keep in mind — whether you are trading in the spot market or other markets — is to perform your own research and make informed rather than impulsive decisions.

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