There are two major classifications of marketplaces from which investors can earn substantial gains. These are futures market and spot market. While the former involves contracts based on future prices and no deliveries, the latter is a place where trades are made with current prices and it involves instant transactions of securities.
Are you planning to participate in spot trading and don’t know where to start? Keep reading till the end to learn more about spot trading.
What Is Spot Trading?
The process of buying or selling an asset at the current market price for instant delivery is called spot trading. Also known as spot transaction, this trade occurs when a trader purchases or sells commodities, foreign currencies, or any financial instrument at a given date. This is the spot date. The spot date refers to the day when a spot transaction is typically settled, meaning when the funds involved in the transaction are transferred. The spot date is calculated from the horizon, which is the date when the transaction is initiated.
Foreign exchange spot contracts are one of the popular spot trades that take place. Spot trading contracts take place between two financial institutions or a company and financial institutions. They keep changing in the spot market.
What Is a Spot Market?
A spot market is a marketplace for financial instruments or commodities where immediate settlements of orders and instant deliveries take place. However, in a practical scenario, the spot market requires two business days (T+2) to process the transaction successfully.
This marketplace is also known as the cash market or liquid market as traders settle payments upfront, unlike future markets. There are two main types of spot markets – over-the-counter (OTC) and organised market exchange. Exchanges are spot markets that enable electronic trading.
Unlike future or non-spot markets, payments and trades occur on the same day. Furthermore, trades in Indian spot markets follow the T+2 day rule. This implies the deliveries will occur two days later. However, steps are being taken to make spot transactions happen in T+1 day.
Physical trading of commodities usually involves settlement with cash by buyers and delivery of receipts for commodities held in authorised warehouses. The commodities delivered in this way are evaluated by an assayer before the settlement of the transaction. This means that instant delivery is not practically possible and the actual settlement takes around 5-7 days.
When future contracts are about to expire, they become cash trades as buyers and sellers need to complete the transactions immediately.
What Are Types of Spot Markets?
There are two types of spot markets where a trader can participate in spot trading.
- Market Exchanges
Buyers and sellers meet and interact to bid on and present financial instruments and commodities to trade. The trading takes place on an electronic trading platform or a trading floor. Electronic trading platforms enable traders to instantly determine the price of an asset in order to serve a large number of traders simultaneously.
Brokers, who are also market makers, carry out these trading processes. In exchanges, buyers’ bids and sellers’ offers determine the contract prices. These are subject to instant change in every millisecond or minute. Therefore, a spot trader must be minutely aware of the rise and drop of prices to make his/her best bid.
- Over-the-Counter (OTC)
In OTC trading, the trade of securities and financial instruments happens between buyers and sellers directly. In this marketplace, participants meet to trade bilaterally without any involvement of a third party. There is no requirement for standardisation of assets like in the case of exchange spot markets.
Difference between Spot Trading and Future Trading
As mentioned earlier, the spot market is a marketplace where buying and selling of contracts and deliveries happen immediately. Currencies and commodities are the most used and popular financial instruments of the spot market. Here, goods and financial assets are sold for cash and the immediate delivery process begins. Mandis are a kind of spot market in India where the trading of physical commodities happens in exchange for immediate cash.
Future trading, on the other hand, deals with the transaction of financial instruments on a specified date. Traders sign a futures contract with an agreed-upon date and price to sell or purchase the asset. In the futures market, these contracts are standardised, allowing traders to speculate upon the future prices of the underlying asset.
In spot markets you can easily purchase or sell commodities on the same day prices are low or high. However, in future trading, you must purchase or sell commodities on the given date regardless of their price. This implies, traders are at high risk of incurring losses or earning substantial gains from future markets owing to the unpredictable nature of this marketplace.
In the Indian context, commodities in future markets do not depend on an area’s geography. One can engage in future trading on online trading platforms to receive or sell commodities like vegetables, metals or other instruments from any part of India.
However, spot markets are highly dependent on the region. It is not feasible or practically possible for any trader to carry fresh vegetables or other items from one state to another. This might hamper the condition of commodities if they need to travel very long distances. Therefore, traders investing in physical commodities tend to prefer future trading over spot trade.
This blog has hopefully given you the information you needed on spot trading. Traders need to keep in mind every aspect of spot trading before investing here. Investors should also know that in spot markets, assets have a spot price and a forward price which later acts as future prices in future contracts. With the right guidance, you can yield substantial benefits from spot trading.
Frequently Asked Questions
What are cash undated markets?
Cash or undated markets are different names for spot markets. These refer to the same marketplace where buying and selling of commodities happen on the same day as spot trading.
What are some major features of spot trading?
In spot trading, transactions take place with the ruling price, also known as the spot price or spot rate. Also, the transfer of funds and asset delivery can happen instantly or within 2 business days.
What are the trade channels for spot trading and futures trading in India?
Trading activities can take place online via electronic platforms for both spot trading and futures trading. Spot trading also happens via physical marketplaces like wholesale and retail markets or Mandis in India.
Darshan is an up-and-coming Investment analyst making headway in the field of capital markets. He has completed his Chartered Accountancy and CFA Level 1 exam. He is currently working as a Credit Associate in Wint Wealth.