An Introduction to Spot Market
A market for financial instruments such as commodities and securities which are traded immediately or on the spot. In spot markets, spot trades are made with spot prices. Unlike the futures market, orders made in the spot market are settled instantly. Spot markets can be organised markets or exchanges or over-the-counter (OTC) markets. Its also referred to as the “physical market” or the “cash market” because of the instant and immediate pace and movement of orders made as orders are made at current market prices. Market prices are unlike forward prices, which cover prices at a later date. It is important to know the difference between the spot market and the futures market, as well as the difference between spot prices and futures prices. This difference — known as the time spread is important economically because it illuminates the market’s expectations about futures prices.
A spot trade is the purchase or sale of a foreign currency, financial instrument or commodity for instant delivery. Most spot contracts include physical delivery of the currency, commodity or instrument; the difference in price of a future or forward contract versus a spot contract takes into account the time value of the payment, based on interest rates and time to maturity.Foreign exchange spot contracts are the most common and are usually for delivery in two business days, while most other financial instruments settle the next business day. The spot foreign exchange (forex) market trades electronically around the world. It is the world’s largest market, with over $5 trillion traded daily; its size dwarfs the interest rate and commodity markets.
The Current Price (The current price, also known as the market value, is the price at which goods are currently being sold in the market. Similar to market price, which is the price determined by buyers and sellers in an open market.) of a financial instrument is called the spot price. It is the price which a particular instrument can be sold or bought during a particular time and specified place.
Organised Markets or Exchanges
Financial markets are complex organizations with their own economic and institutional structures that play a critical role in determining how prices are established—or “discovered,” as traders say. These structures also shape the orderliness and indeed the stability of the marketplace. Financial instruments like securities and commodities are bought and sold on exchanges that use, make or change the present market price of the product. Exchanges are highly organized markets that bring together dealers and brokers who buy and sell commodities, securities, currencies, futures, options and other financial instruments. Exchanges are divided according to objects sold and type of trade. Under objects sold, exchanges are divided according to stock exchange, commodities exchange, and foreign market exchange. Under type of trade, exchanges are divided according to classical exchange and future exchange. Trades under classical exchanges are for spot trades, while future exchanges are for derivatives.
Over-the-counter markets trades happen directly between a buyer and a seller.
The OTC is a market where financial instruments such as currencies, stocks and commodities are traded directly between two parties. OTC trading has no physical location — trading is done electronically. It does not take place, however, on the stock exchanges, e.g. at the LSE, Euronext, NYSE. Instead, trading is usually carried out through a dealer network. Agreements on what, how many, for what price and under what conditions, are all made based on mutual consent but are not standardised like financial instruments traded on stock exchanges.On one hand, exchanges have the benefit of managing liquidity. This lowers risks involved in the possibility of one party not completing the trade. Exchanges provide traders transparency and follow the current market price. On the other hand, OTC markets do not necessarily follow the common rules of an exchange market. Because of this, buyers and sellers get to create contracts that may be nonstandard. The prices of the products involved may also be unpublished. These trades are done on the spot as well.