What is the meaning of a spot market?
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A spot market is a financial market where assets are bought and sold for immediate delivery and settlement at current market prices.
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.
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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:
Also Read: What Is Margin Trading in the Forex Market
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:
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.
The trade date, represented as ‘T’, is the date on which you place your buy or sell order in the spot market.
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.
Spot trades are executed when the buyer and seller agree on a price, known as the spot price. The process begins with order placement, where the buyer and seller place buy or sell orders. These orders are filled immediately upon entry into the marketplace, ensuring quick transaction execution.
The delivery timeline for most spot trades, including foreign exchange (Forex) contracts, is typically within two business days (T+2). However, some financial instruments may settle the next business day, providing a swift turnaround.
One of the key features of spot settlement is its flexibility. Unlike futures options, which often involve long-term commitments, spot trades offer immediate exchange, enhancing market efficiency and liquidity. This flexibility allows participants to react quickly to current price conditions, facilitating seamless transactions across various asset classes, including currencies, commodities, and securities. This immediacy and adaptability make spot trades a preferred choice for many market participants.
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.
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.
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.
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.
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:
The limitations of spot trading include the following:
Also Read: Be Aware of Buy and Hold strategy in the Stock Market
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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A spot market is a financial market where assets are bought and sold for immediate delivery and settlement at current market prices.
Spot trading can be safe with proper risk management. In India, spot trading is well regulated and transparent.
Spot trading involves immediate delivery of assets, while forward trading involves contracts to buy or sell assets at a future date at a predetermined price.
The future spot price is estimated using factors like current spot price, interest rates, and time to maturity, but it can be influenced by market conditions.
To trade spot markets, open an account with a broker, conduct market research, place buy or sell orders, and manage your trades using risk management strategies.
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