What Is a Spot Market and How to do Spot Trading?/ Exchanges vs. over-the-counter
The spot market or cash market is a public financial market in which financial instruments or commodities are traded for immediate delivery. It contrasts with a futures market, in which delivery is due at a later date. In a spot market, a settlement normally happens in T+2 working days, i.e., delivery of cash and commodity must be done after two working days of the trade date.
A spot market can be through an exchange or over-the-counter (OTC). Spot markets can operate wherever the infrastructure exists to conduct the transaction.
The spot energy market allows producers of surplus energy to instantly locate available buyers for this energy, negotiate prices within milliseconds, and deliver energy to the customer just a few minutes later. Spot markets can be either privately operated or controlled by industry organizations or government agencies.
They frequently attract speculators, since spot market prices are known to the public almost as soon as deals are transacted. Examples of energy spot markets for natural gas in Europe are the Title Transfer Facility (TTF) in the Netherlands and the National Balancing Point (NBP) in the United Kingdom.
What Is a Spot Market
The spot market is where financial instruments, such as commodities, currencies, and securities, are traded for immediate delivery. Delivery is the exchange of cash for the financial instrument. A futures contract, on the other hand, is based on the delivery of the underlying asset at a future date.
Spot markets are also referred to as “physical markets” or “cash markets” because trades are swapped for the asset effectively immediately. While the official transfer of funds between the buyer and seller may take time, such as T+2 in the stock market and in most currency transactions, both parties agree to the trade “right now.”
A non-spot, or futures transaction, is agreeing to a price now, but delivery and transfer of funds will take place at a later date. Futures trades in contracts that are about to expire are also sometimes called spot trades since the expiring contract means that the buyer and seller will be exchanging cash for the underlying asset immediately.
What Is a Spot Market and How to do Spot Trading?
Spot trading involves directly purchasing or selling financial instruments and assets such as cryptocurrencies, forex, stocks, or bonds. Delivery of the asset is often immediate. Spot trading occurs in spot markets, which are either exchange-based or over-the-counter (directly between traders). When trading on spot markets, you can only use assets you own – there is no leverage or margin.
Centralized exchanges for spot trading manage regulatory compliance, security, custody, and other factors to make trading easier. In return, exchanges take transaction fees. Decentralized exchanges provide a similar service but through blockchain smart contracts.
Spot trading offers a simple way to invest and trade. With crypto investing, your first experience will likely be a spot transaction in the spot market, for example buying BNB at the market price and HODLing.
Spot markets exist across different asset classes, including cryptocurrencies, shares, commodities, forex, and bonds. You’re probably more familiar with spot markets and spot trading than you think. Some of the most popular markets, like the NASDAQ or NYSE (New York Stock Exchange), are spot markets.
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A spot market is a financial market open to the public where assets trade immediately. A buyer purchases an asset with fiat or another medium of exchange from a seller. Delivery of the asset is often immediate, but this depends on what’s being traded.
Spot markets are also known as cash markets because traders make payments upfront. Spot markets come in different forms, and third parties, known as exchanges, typically facilitate trading. You can also trade directly with others in over-the-counter (OTC) trades. We’ll dive into these later.
What’s spot trading?
Spot traders try to make profits in the market by purchasing assets and hoping they’ll rise in value. They can sell their assets later on the spot market for a profit when the price increases. Spot traders can also short the market. This process involves selling financial assets and repurchasing more when the price decreases.
The current market price of an asset is known as the spot price. Using a market order on an exchange, you can purchase or sell your holdings immediately at the best available spot price. However, there’s no guarantee that the market price won’t change while your order executes. There also might not be enough volume to satisfy your order at the price you wanted. For example, if your order is for 10 ETH at the spot price, but only 3 are on offer, you will have to fill the rest of your order with ETH at a different price.
Spot prices update in real-time and change as orders match. Over-the-counter spot trading works differently. You can secure a fixed amount and price directly from another party without an order book.
Depending on the asset, delivery is immediate or typically within T+2 days. T+2 is the trade date plus two business days. Traditionally, shares and equities required the transfer of physical certificates. The foreign exchange market also previously transferred currencies via physical cash, wire, or deposit. Now with digitized systems, delivery takes place almost immediately. Crypto markets, however, operate 24/7 allowing for usually instant trades. Peer-to-Peer trading or OTC can however take longer for delivery.
Exchanges vs. over-the-counter
Spot trading isn’t just limited to one single place. While most individuals will do spot trading on exchanges, you can also trade directly with others without a third party. As mentioned, these sales and purchases are known as over-the-counter trades. Each spot market has its own differences.
Exchanges come in two forms: centralized and decentralized. A centralized exchange manages the trading of assets like cryptocurrencies, forex, and commodities. The exchange acts as an intermediary between market participants and as a custodian of the traded assets. To use a centralized exchange, you have to load up your account with the fiat or crypto you want to trade.
A serious centralized exchange needs to make sure transactions occur smoothly. Other responsibilities include regulatory compliance, KYC (Know Your Customer), fair pricing, security, and customer protection. In return, the exchange charges fees on transactions, listings, and other trading activities. Because of this, exchanges can profit in both bull and bear markets, as long as they have enough users and trading volume.
A decentralized exchange (DEX) is another type of exchange most commonly seen with cryptocurrencies. A DEX offers many of the same basic services as a centralized exchange. However, DEXs match buying and selling orders through the use of blockchain technology. In most cases, DEX users don’t need to create an account and can trade directly with one another, without the need for transferring assets onto the DEX.
Trading occurs directly from the traders’ wallets through smart contracts. These are self-executing pieces of code on a blockchain. Many users prefer the experience of a DEX as it provides more privacy and freedom than a standard exchange. However, this comes with a tradeoff. For example, the lack of KYC and customer support can be a problem if you happen to have issues.
Some DEXs use an order book model, such as Binance DEX. A more recent development is the Automated Market Maker (AMM) model like Pancake Swap and Uniswap. AMMs also use smart contracts but implement a different model to determine prices. Buyers use funds in a liquidity pool to swap their tokens. Liquidity providers who provide the pool’s funds charge transaction fees for anyone who uses the pool.
On the other end, we have over-the-counter trading, sometimes known as off-exchange trading. Financial assets and securities are traded directly between brokers, traders, and dealers. Spot trading in the OTC market uses multiple communication methods to organize trades, including phones and instant messaging.
OTC trades have some benefits from not needing to use an order book. If you’re trading an asset with low liquidity, such as small-cap coins, a large order can cause slippage. The exchange often can’t totally fill your order at the price wanted, so you have to take higher prices to complete the order. For this reason, large OTC trades often get better prices.
Note that even liquid assets like BTC can experience slippage when the orders are too large. So large BTC orders can also benefit from OTC trades.
How to spot trade on Binance
Spot trading on Binance is a simple process once you’ve signed up for a Binance account. Let’s take a look at Binance’s classic exchange view and explore how to make a spot trade. You can find the trading platform by hovering over [Trade] and clicking [Classic] on the Binance homepage.
You’ll now see the classic trading view, which contains a few different sections of interest.
- This option lets you choose the cryptocurrency pair you want to trade on the spot market. You don’t just have to buy cryptocurrencies with fiat, either. You can also exchange them for other coins and tokens on the spot market.
- Here you’ll see the chart view with customizable historical price data. Inbuilt into the window is TradingView, giving you a wide variety of technical analysis tools to use. If you want to learn some basic TradingView techniques, check out our guide here.
- The order book lists all of an asset’s open buy and sell orders organized by price. The green orders are buy orders, and the red are sell orders. When you make a market order to purchase an asset, you take the lowest price on offer. If your order still needs more volume to fill it, it will move up to the next lowest ask price.
- This section is where you’ll create your buy or sell orders. You can see that it’s currently on the [Spot] section. Underneath, you can choose between [Limit], [Market], and [Stop-limit] orders.
Let’s take a look at the most straightforward spot trade you can do: a market order. In our example, you want to purchase $1,000 (BUSD) worth of bitcoin (BTC). To do this, all you need to do is input 1,000 into the [Total] field and click [Buy BTC]. The exchange will deliver the BUSD immediately to the seller, and you will receive $1,000 (BUSD) worth of BTC.
Advantages and disadvantages of spot markets
Every type of trading and strategy you’ll encounter has its advantages and disadvantages. Understanding these will help you reduce risk and trade more confidently. Spot trading is one of the more simple ones, but it still has strengths and weaknesses.
Advantages of spot markets
- Prices are transparent and only rely on supply and demand in the market. This aspect contrasts with the futures market that often contains multiple reference prices. For example, the mark price in the Binance futures market is derived from other information, including the funding rate, price index, and Moving Average (MA) Basis. In some traditional markets, the mark price might also be affected by interest rates.
- Spot trading is straightforward to take part in due to its simple rules, rewards, and risks. When you invest $500 on the spot market in BNB, you can calculate your risk easily based on your entry and the current price.
- You can “set and forget”. Unlike derivatives and margin trading, with spot trading, you don’t need to worry about being liquidated or getting a margin call. You can enter or exit a trade whenever you want. You also don’t need to keep checking your investment, unless you want to make short-term trades.
Disadvantages of spot markets
- Depending on what you’re trading, spot markets can leave you with assets that are inconvenient to hold. Commodities are perhaps the best example. If you spot purchase crude oil, you’ll have to take physical delivery of the asset. With cryptocurrencies, holding tokens and coins gives you a responsibility to keep them secure and safe. By trading futures derivatives, you can still get exposure to these assets but settle with cash.
- With certain assets, individuals, and companies, stability is valuable. For example, a company wanting to operate abroad needs access to foreign currency in the forex market. If they rely on the spot market, expenditure planning and incomes would be very unstable.
- Potential gains in spot trading are much less than in futures or margin trading. You can leverage the same amount of capital to trade larger positions.
Spot trading in spot markets is one of the most common ways for people to trade, especially beginners. Although it’s straightforward, it’s always good to have extra knowledge of its advantages, disadvantages, and potential strategies.
However, if there is anything you think we are missing. Don’t hesitate to inform us by dropping your advice in the comment section.
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