Spot Trading

Spot Trading

What is spot trading?

Spot trading is a method of buying and selling assets at the current market rate, called the spot price, with the intent to receive the underlying asset immediately. Spot market trading is popular with intraday traders as they can take short-term positions with low spreads and no expiration date.

Spot traders try to profit in the market by buying assets in the hope that they will appreciate in value. They can sell their assets later on the spot market for a profit when the price rises. Spot traders can also take short positions in the market. This process involves the sale of financial assets and their repurchase when the price falls.

Types of spot transactions

Types of transactions on spot exchanges are distinguished by the principle of the speed of their completion.

  1. TOD transaction comes from "today". Such a transaction assumes that the transaction's settlement and the asset's delivery will occur on the day of the transaction.
  2. TOM transaction is short for "tomorrow". This type of transaction involves the settlement of the transaction and the delivery of goods in one day.
  3. SPT transaction comes from the "spot". This type of transaction involves the transaction’s settlement and the asset’s delivery 2 days after the transaction.

Please note that all terms of transactions are calculated in working days. This is important to understand, especially when making TOM and SPT trades on Friday at the end of the week.

Types of spot trading markets

Generally, there are two different types of markets in which you can place spot trades. These are over-the-counter markets and large market exchanges such as the NYSE or Nasdaq.

OTC Markets

OTC trading is a type of spot trading in financial assets and securities, carried out directly between brokers, traders, and dealers.

In other words, assets are traded nor on centralized exchanges, but via broker-dealer networks. This nature of OTC markets is what makes Forex trading available 24 hours a day. Moreover, over-the-counter trading can go beyond trading of only standardized financial products: there may be different contract sizes on the OTC market. Finally, as there’s no central authority, each party may face credit risk regarding its counterparty. Dealers, also known as market makers, buy and sell financial instruments from their own inventories.

Market exchanges

A centralized exchange manages the trading of assets such as Forex, commodities, and cryptocurrencies. The exchange acts as an intermediary between market participants and the custodian of traded assets. In order to use the centralized exchange, you must have the fiat currency or cryptocurrencies you want to trade on your account.

Major market exchanges include world famous markets such as the NYSE and Nasdaq in the US, as well as other global markets such as the London Stock Exchange (LSE), Shanghai Stock Exchange (SSE) and Hong Kong Stock Exchange (HKSE). In all major markets, investors can make spot trades for immediate delivery and payment.

Spot trading alternatives

The opposite of spot trading is a transaction in which there is no immediate payment and delivery of the investment. Traders who only want to invest at certain prices and within predetermined timeframes can invest in derivative contracts such as:

Options contracts are contracts that give the holder the right, but not the obligation, to buy a security at a predetermined price and date.

Futures contracts are contracts to buy or sell a predetermined number of securities at a specified price and in the future.

Neither options nor futures contracts constitute actual ownership of the underlying security. Instead, they are contracts to buy or sell securities at a later date between two parties.

Spot Trading vs. Margin Trading

The difference between spot trading and margin trading comes down to risk versus reward. You get this with spot trading, which is quite simple: you buy or sell an asset on an exchange directly. Once you buy or sell, the order is done, and you own what you own.

Trading on margin, on the other hand, is more complex and much riskier. However, the potential rewards are much higher than with spot trading. The risk and reward scale in margin trading is typically between 2x and 100x. During margin trading, most brokers allow you to trade up to 20x leverage, or 1:20, although some go as high as 100x, or 1:100. At the latest rate, you can trade $100 and buy $10,000 by borrowing $9,900.

The reason is simple: you borrow money to trade on the price of an asset going up or down. If you're right, great! You repay the loan and make a much bigger profit than you could by trading only your own money. However, if you’re wrong, you still owe the broker the amount you lent, plus interest and transaction fees.

To a certain extent, margin trading is similar to spot trading. However, the same volatility seen in the spot market is exacerbated by leveraged positions in margin trading, making smaller investments riskier in terms of costs and rewards.

If you’re doing a margin trade, you need to understand that when the margin level decreases, more collateral (or less leverage) must be applied to the position. This is called a margin call. The higher the leverage ratio, the faster the margin level can plummet.

However, if margin trading is successful, high leverage ratios can help traders reach excessive levels of success relatively quickly. For example, traders can often trade in a range of 2x to 10x, making profits ranging from almost double to huge.

Example of a spot Forex transaction

Let's say you want to open the trade with the GBPUSD currency pair. The current price is 1.35250 and based on your trading strategy you think it will go up. You buy at 1.35250, and choose how much you want to risk per point of movement. If you risk $1 per point, each time the price moves one point up or down, you will make or lose $1. If the price rises to 1.3600, the trade will make a profit of $750 (750 points x $1). If the price falls to 1.3500, the trade will lose $250 (250 points x $1).

Traders can control when they cut losses and when they profit with Stop Loss and Take Profit orders. Optionally, you can specify prices for these orders when making a transaction by clicking the buy or sell button on the currency pair.

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2022-07-04 • Updated

Frequently asked questions

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