Based on the different things such as the time of the transaction, type of financial instrument, and settlement terms, the financial market can be categorised into different kinds. One such kind is the spot market. It is for immediate traders. But in this article we are going to look at the deeper meaning of the spot market and more.
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Spot market meaning
Spot market is the category of financial market where various instruments like stocks, currencies, commodities, bonds etc are traded with the purpose of immediate delivery. In such cases, the buyer and seller agree on a certain price of a commodity and the transaction is made then and there. The transaction is settled pretty quick, usually within two days.
Not just financial instruments, other commodities such as precious metals like gold and silver, and crude oil, among other things are also traded on the spot market. In fact, so are currencies. The value of a currency is determined by the demand and supply in the market. As the spot market is liquid and highly transparent, the prices here are based on the market conditions.
These markets are also known as cash markets or liquid markets, because the transactions are instant. It might take time to process the transactions and transfer the funds in real time, but the agreement of the transaction is done instantly. Most exchanges and over-the-counter (OTC) markets provide the scope of spot trading.
What is the spot price?
The current price at which a financial instrument is available or traded is called the spot price. In simpler words, spot price is the price at which an instrument can be sold or bought at any given point. It is the buyers and sellers who create the spot pricing of an instrument by posting about their orders. In a market as liquid as spot markets, the spot price of an instrument may change in a matter of seconds.
Also Read: Security Market Line
Understanding spot market better
By now, it must be clear that in spot markets, the payments and delivery happens on the spot and instantly. In most markets, the cash transfer and delivery of the commodity takes at least 2 working days, which is referred to as T+2.
In forward and futures markets, the buyer and seller make an agreement to trade at a later date and at a future price of the financial instrument, and even the delivery is expected at a future time. The spot market directly contradicts these markets. Here is an example of a spot market.
Say Mr. X wants to buy 1,000 shares of a company on the stock exchange. He will simply need to make a call to his stock broker that he wants to buy 1,000 shares at the existing price. The broker will make the cash purchase of the shares from the seller, and Mr. X will get the ownership of the shares as soon as the transaction is processed.
Salient features of the spot market
Here are some of the features of the spot market:
- The tradings and transactions are done based on the current price of the item, also known as the spot price.
- Delivery of the commodity takes place either immediately or in two days.
- Transfer of funds, too, are either instant or happens in two days.
Types of spot markets
There are two types of spot markets: over-the-counter (OTC) and market exchange.
-Over-the-counter (OTC)
This is where buyers and sellers meet and trade directly through consensus. In this kind of spot markets, the trade is not overseen or regulated by any central exchange institution or third-party supervisor. In an OTC kind of transaction, the price can either be a spot price or a future price. Because of the lack of any terms or standards, the rules of OTC tradings are determined only by the two parties involved. It is the buyer and seller who negotiate the terms of the trade. A good example of the exchange market is the currency exchange market.
-Market exchanges
In an organised market exchange, buyers and sellers bid to trade financial instruments and commodities. The trading happens either on a trading floor or on an electronic trading platform, which has made the process of trading more efficient and hassle-free. Thanks to these electronic trading platforms, the prices of commodities are decided more instantly.
Market exchanges may either deal in various kinds of financial commodities and instruments, or they may carve their own niche and deal with just a few specific kinds of assets. In market exchanges, trading is generally done via brokers who function as the market makers. Unlike the OTC market, in the exchange market, the assets traded adhere to a certain set of standards and terms.
It is also likely that for the assets that are being traded, there will be contract prices involved for specific quantities or values. The prices of the assets are determined through the bids of many buyers and offers of many sellers, unlike spot prices which change every second.
Market exchanges are also regulated. Every procedure of trading and transactions here is standardised.
Pros of the spot market
There are several advantages of the spot market. They are as follows:
- One of the best things about the spot market is that it is quite transparent and facilitates trading and transactions under complete transparency too. The transactions are done on the basis of the prevailing prices, which is known to the general public as well as to the concerned parties.
- Traders have the option of finding a better deal if they are not happy with the current terms and prices.
- Trades are completed on the spot.
- For spot market transactions, a lot of times there doesn’t need to be any minimum capital requirements.
Also Read: What are common stocks
Cons of the spot market
The spot market also has a bunch of disadvantages. They are as follows:
- Trading on the spot market can have significant risks, especially on financial commodities or instruments that are volatile. Investors buy these on the spot based on the current inflated price, before they can even find the true price of these assets, because of the volatility.
- If any party notices any irregularities or issues after the spot trading is done, they might not be a recourse.
- Spot markets and tradings generally lack planning.
- It is not flexible with timings, because the delivery is done immediately.
