By
David Dombrowsky

Spot Trading Explained

Published on
September 5, 2023

What is spot trading? Spot trading entails people buying and selling securities at the prevailing market rate. Unlike Contract for Difference trading, people use spot trading to take delivery of the underlying asset at an agreed spot date.


What You Need To Know About Spot Trading

Source: Blockbuild.Africa


Trading in the spot market is common as it involves vigorously opening and closing short-term positions with no expiry date. Delivery of the assets is often immediate, and there is no leverage or margin trading. Therefore, traders can only use the assets they own to trade. Buying and selling at the prevailing price can occur in centralized or decentralized exchange and over the counter.

Spot trading occurs in different asset classes, from stocks to currencies, commodities and cryptocurrencies. People can purchase the security using fiat or another acceptable medium of exchange. Delivery is immediate, depending on the asset. Traders must make cash payments upfront to receive the asset.

The markets that facilitate spot trading come in different forms. Centralized exchanges act as intermediaries tasked with managing the trading of assets like stocks, commodities, cryptocurrencies and forex. In addition, the exchanges serve as a custodian of the traded assets.

To be able to use a centralized exchange to buy or sell an asset, one must load up their accounts with fiat or crypto. In return, the exchange will provide a platform for buying and selling smoothly. In return, the centralized exchange makes money by charging fees for every trade people carry out on the platform.

The centralized exchanges can always be profitable as long as sufficient traders place orders on the platform. They can also make money in bull and bear markets, given the buying and selling.

On the other hand, decentralized exchanges offer almost all the basic services centralized exchanges offer in spot trading. The only difference is that decentralized exchanges match buying and selling orders through blockchain technology and thus do not act as an intermediary between the traders.

In this case, traders trade directly with one another without having to transfer assets into the exchange. As a result, the fees of trading in decentralized exchanges are some of the lowest in the financial markets.


How Spot Markets Work

In spot trading, traders try to make purchases in the hope that the underlying asset prices will rise. They can then sell the assets in the spot market for a profit once the price increases significantly. In addition to buying, traders can also short the market and profit when the underlying security price drops.

The current price at which a security is bought or sold is the spot price. Using market order, you can buy or sell holdings in stocks, currencies, cryptocurrencies or commodities at the best available spot price.

Nevertheless, there is usually no guarantee that the market price will stay the same when the order is executed. Given that prices change rapidly in the spot market due to market volatility, there can be some difference between the price at which one wants to buy or sell and the price at which the market order is executed. Additionally, whenever there is no sufficient volume in the market, there might be delays in the execution of the order.

Depending on the asset, delivery should be immediate once the payment is made. In some cases, delivery occurs T+2 days, the date a trade is executed, plus two business dates. For example, spot trading shares and equities often transfer physical certificates that take a maximum of two days.

In the foreign exchange market, delivery often occurs via physical cash, wire or deposit. Thanks to digitized systems, delivery is now almost immediate. The cryptocurrency market is entirely different, given that the market operates 24/7. Delivery of the tokens is usually prompt, allowing traders to deposit the private address that shows ownership of the tokens into crypto wallets.


Difference Between Spot Markets and the Futures Market

While spot trading and futures markets provide a reliable way of speculating on prices of financial assets, they differ. In the spot markets, payment must be made upfront for the assets bought or sold, and delivery must be made immediately.


Cryptocurrency software development: Difference between spot and futures  trading exchange - Antier Solutions

Source: antiersolutions.com


On the other hand, in the futures market, contracts are only paid for at a future agreed date. In the futures market, a trader agrees to trade a certain amount of goods at a specific price in the future. In contrast, trades are executed at the current spot price in the spot markets.


Difference Between Spot Trading and Margin Trading

Spot trading requires traders to purchase an asset and take delivery immediately. In margin trading, traders can borrow funds, also known as leverage, and buy and sell much larger positions. In margin trading, there is no taking of delivery as traders look to profit from price differences using tools like CFDs.


Spot Trading FAQ


Is Spot Trading Profitable?

Spot trading, like any other form of investing, can be profitable and lead to losses when the market goes against the orders placed. Nevertheless, potential gains in the spot markets are much lower than in margin trading, whereby leverage amplifies gains.

Is Spot Trading Safe?

Spot trading is one of the safest ways of investing, as prices are transparent and based on supply and demand. It is also relatively less risky than margin trading, whereby leverage magnifies losses.

Is Spot Trading Haram?

Spot trading is permissible under Islamic laws, as it involves the physical exchange of items upon payment. In contrast, futures contracts are not permissible as they involve speculation and uncertainty.

Can You Short in Spot Trading?

Yes, you can open sell or short positions in the spot market. The only difference is that the selling must occur on an intraday basis. Consequently, any opened sell position must be closed before the end of a trading day.


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