Spot market, also known as cash market or physical market, is a place where financial instruments or commodities are sold for cash and delivered immediately or within a short period of time. Unlike in a futures market, in a spot market, delivery takes place no later than within 2 business days of the transaction date. A fine example of a commodity traded in a spot market is crude oil. It’s sold at the current price and delivered later.
Instruments traded in a spot market include
- precious metals,
- natural gas,
- grain, etc.
Realizing that transfer of funds between the buyer and the seller may take some time, the parties agree to the trade right now. By placing their buy and sell orders, the parties create a spot price. A spot price is a price at which an asset can be sold and bought at a specified time and in a specified place.
In fact, all financial markets fall into two main types, spot markets and forward markets. A forward market is over-the-counter market where assets are bought and sold for future delivery. In other words, a transaction between the parties is contracted today and implemented in the future.
Here are the major characteristics of a spot market:
- interest rates do not apply;
- currency exchange rates are fixed and unified;
- prices are directly affected by the current supply/demand ratio;
- prices are more volatile than in a forward market.
A spot market is the right place for traders who want to purchase an asset and own it immediately. All financial settlements are made right on the spot and in full.
The foreign exchange market, or Forex, is the biggest spot market in the world. It’s a place where individuals and companies from all over the globe trade currencies, such as US dollars, Canadian dollars, Australian dollars, Swiss francs, British pounds, Japanese yens, Euros, and so on. While most currency trades take up to 2 business days to settle, US dollar/Canadian dollar trades settle the next business day. The Forex market is characterized by high levels of volatility and liquidity. Most trades are made between 8 and 12 am in the financial markets of Europe and USA (New York).
What makes spot contracts so popular among traders? Of course, the biggest attraction is immediate implementation (payment + delivery). A spot contract is executed on the trade date, which minimizes financial risks for both parties.
It’s worth noting that spot prices provide the most accurate picture of what’s going on in the market. By monitoring sport prices, you can easily identify major tendencies that characterize the current market situation.
The understanding of how spot prices are set and how they affect prices in other financial markets gives you a significant edge in trading. It’s a good training for any trader, whether a beginner or a pro. What’s more, spot contracts are a great chance to grow your trading account.