What is a Spot Market?

UTC by Adedamola Bada · 7 min read
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What is a Spot Market?

Guide to what is spot market and it’s a definition. Check out examples of the cash market along with its components and key terms.

A spot market, sometimes called a cash market, is a market in which financial instruments like stocks or commodities are purchased or delivered with immediate alacrity. The spot market varies from other markets like the futures market in the sense that the delivery of financial instruments sold happens immediately.

Trades in the futures market are made on a certain date and are usually set to be completed months into the future. For instance, if you want to own shares in Apple, you’ll head over to a spot market in which shares are traded (the New York Stock Exchange or NASDAQ) and purchase them immediately.

The foreign exchange market, commonly known as Forex is one of the biggest spot markets on the globe. Organizations, individuals and governments are consistently exchanging a currency for another.

The spot market is primarily subjective to the forces of demand and supply. Other markets like the futures market are influenced by anticipation of future events that could affect prices like climate, costs of commodities, etc.

When looked upon from a differing perspective, a futures contract about to expire can also be referred to as a spot trade. This is primarily because the contract which is about to expire would mean cash would be exchanged for the financial instrument swiftly.

Spot Price

The current price of a commodity, stock, bond, etc. is called the spot price. A very big number of traders in the market buy or sell a commodity at the spot price. The spot price can be influenced when buyers and sellers create buy and sell orders. In very volatile markets, the spot price changes quite fast. This is due to the fact that a large number of traders are involved in the market and orders quickly get filled with fresh ones getting into the market.

For instance, when the forex market is observed, the spot price of Majors (the seven currencies paired with the USD which include JPY, GBP, CAD, AUD, NZD, CHF, EUR) change very fast during trading hours and come to a peak when two trading sessions overlap. During these periods, the price of a currency can consistently change in milliseconds.

Types of Spot Market

There are two types of spot markets namely the exchange-traded market or over the counter (OTC) market. The exchange-traded market allows the congregation of buyers and sellers all in one place while the over the counter market occurs with traders who are a closed group but are not necessarily in the same location.

Exchange-Traded Market

The exchange-traded market gives both buyers and sellers the spot price at which the financial instruments can be purchased and sold. It also brings all forms of traders who deal in financial instruments to a central location. The New York Stock Exchange is probably the most popular exchange-traded market since its inception in 1792. There are more than 100 exchange-traded markets in the world today.

Exchanges go beyond just providing a central location for traders to buy and sell securities. They set guidelines and restrictions that allow an uninterrupted and fair flow of trading. What an exchange does to receive a bid and publicly show the price at which the bid was made to everyone in its market. A trader who feels satisfied with the price quoted can buy or sell. If the trader is disgruntled with the price, a counter-bid can be made.

Exchange-traded markets can use different mediums to communicate a bid to its traders. Voice, hand signals or computer commands can be used. Once a buyer completes an order with a corresponding seller, the price at which the instrument was traded would be communicated to other traders in the exchange. This leads to a fair market where a trader can decide to make a sale at any price for a corresponding buyer to make a purchase so far both parties follow the rules of the exchange.

In times past, voice calls and physical presence was needed in order to make trades on exchanges. However, with the introduction of the internet and the computer, trades can be made from home. Several traditional trading floors have closed with large stock exchanges like the London Stock Exchange and NASDAQ and futures exchanges like Eurex going totally electronic.

Over-the-Counter Market

In contrast to exchange-traded markets, over-the-counter markets do not exactly have a central location. Although they have a well-defined structure, the market setting is sometimes almost informal. The market price is influenced by a dealer who lists prices to different clients. However, this is where the informality of the OTC market sets in; a different price can be quoted to different clients. Also, over the counter deals can fail at any time.

Over-the-counter markets do not have set rules and generally do not allow for a free flow of market information. An OTC dealer frequently uses the phone, emails and chat applications to make deals. They also make use of electronic bulletin boards to post price quotes. When two dealers or a customer and dealer negotiate through calls or instant messaging, it is known as bilateral trading. The best way a buyer or seller can get price information in the OTC market is to have a reasonably large network of over the counter dealers to ask price quotes from.

There are two parts to the OTC market. The customer market is where dealers trade with clients like individuals or firms. Dealers typically make use of electronic messages that list numerous securities and the prices at which the dealers want to buy or sell them. The interdealer market is one where dealers state their prices to one another and help share risk evolving from dealing with a customer like purchasing a bigger trading position. However, one thing to note is that a customer can never get into the dealer market.

Examples of Dealing in the Spot Market

1. Edward has $5,000 that he wants to invest in financial instruments. However, he is not sure about what stocks he should purchase. He peruses over the different stocks he’s seeing in the market. Since he is scared of losing money in the stock market, he decides to invest in blue-chip stocks, those that have consistently delivered dividends over the years. He then proceeds to buy 10 shares of Apple at $200.00. He now has $2000 worth of Apple shares in his name and gets it immediately.

Edward looks for other stocks that could deliver high ROI to him and buys $2000 worth of penny stocks. He gets delivery that same day. He still discovers he has about $995 left. He makes a decision to invest the money in a strengthened currency. He expects China to do well in the coming years and buys the Chinese Yuan with a Demat account in his bank. In two days, his account will be credited with the Chinese Yuan.

2. Jane deals in fabric and comes across an online clothing store in Spain that’s offering a 30% cut on prices for international customers that pay immediately when they purchase the fabric. The offer is closing in a day. Jane who deals in the United States has $10,000 and wants to take advantage of the offer. The EUR-USD rate is 1.1233 and Jane is satisfied with the price and decides to buy the euros

Since she would need immediate delivery of euros to get the discount, she executes a forex transaction to buy $10,000 worth of euro and receives 8,902.34 euros instantly (Using the 1.1233 exchange rate to the dollar). She makes her purchase and is rewarded with the discount since she was able to make payment immediately.

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