Spot Market Trading
The spot market, also known as the physical or cash market, is where assets are exchanged for cash and delivered forthwith. Here, the market deals in the current price of a financial instrument. In this market, compensation happens in X + 2 working days. That is, delivery of the commodity and cash must be accomplished after two working days from the trade date.
There are many benefits to trading the spot market which include:
- Lower capital requirement
- Easy to operate
- Lower transaction costs
- An ever-changing market
- Access to large trading volumes
Spot market trading provides a wealth of profitable trading opportunities so why not give it a try
Spot Market Terminology
Moving forward, there are a couple of terms you need to arm yourself with to better understand how spot market trading works:
Value date: This is the date when a value fluctuating asset’s price is agreed upon. The value date is called into action when possibilities for disagreements exist due to variations in the timing of valuation.
Spot date: This is the normal settlement day when transactions are carried out practically; “on the spot”.
Spot Price: This is the prevailing price at which a security is bought and sold at a particular time and place.
Spot Contract: This is a spot transaction of trading a commodity, security or currency for a settlement.
Cross rates: In the FX market, currencies are quoted against the US dollar (USD). As you would anticipate, not every cross border transaction is conducted wholly in the USD. Merchant invoices are invoiced in an array of currencies. This calls for determining an exchange rate between, say, the Japanese yen and other currencies. Hence, the need to compute a ‘cross rate’ where various currencies are quoted against one another and not just the USD.
How the Spot Market Trading Works
In this market, delivery takes place right away or on the spot. For instance, say you wish to buy Company ABC shares; you would go to the physical market on which the shares are exchanged say, the London Stock Exchange, and make your purchase. In another example, if you desired to buy gold on the cash market, you could visit a coin dealer and trade cash for gold.
The energy spot market allows energy producers with surplus energy to locate available buyers for the said energy, haggle prices within seconds and deliver energy to the buyer a couple of minutes later. The spot market can be government, industry or privately controlled. This market also often attracts speculators because spot market prices are made known to the public as soon as deals are transacted. Two examples of energy cash market for natural gas are the Title Transfer Facility and the National Balancing Point in the Netherlands and United Kingdom respectively.
The forex market is among the largest spot markets in the world. Individuals and companies worldwide are invariably exchanging one currency for another.
Why Understanding the Spot Market Matters
It is easy to confuse the cash market for the futures market and more so spot and futures prices. The difference between spot prices and futures prices is the time spread. This is imperative from an economic standpoint because it elucidates the market forecasts on futures prices.
Spot markets can operate where infrastructure exists. This market can be:
An organized market: Commodities and financial instruments are traded on an exchange using and probably altering the prevailing market price.
Over the counter: In an OTC market, trades are made directly between two parties, such aren’t subject to the laws of an exchange. Contract terms are set between two parties and can be non-standard. The price might not be established.
A Word of Caution
Spot rate movements are fickle during trading days and relying on the cash market for future foreign exchange is risky because it exposes cash flows to adverse variations in foreign currency values. Nonetheless, many have made profits trading the spot market so why not give it a try?