Spot trading refers to the direct buying or selling of financial instruments and assets such as cryptocurrencies, forex, stocks, or bonds.
Spot markets are exchanges or over-the-counter (OTC) exchanges where assets are immediately delivered. There is no leverage or margin when trading on a spot market, which are either exchange-based or OTC.
Exchanges that offer spot trading manage regulatory compliance, security, custody, and other issues to make trading simpler. In return, these exchanges charge transaction fees. Decentralised exchanges accomplish the same thing through blockchain smart contracts.
Spot Trading Basics
Spot trading is a simple way to invest and trade. Your first crypto experience likely involves a spot trade in the spot market, for example buying Bitcoin at the market price and holding it.
Across various asset classes, spot markets exist. You might be more familiar with spot trading and spot markets than you realise. The NASDAQ or NYSE (New York Stock Exchange), for example, are spot markets.
What is a spot market?
A spot market is a financial market open to the public where assets are traded immediately. A buyer purchases an asset using fiat or another medium of exchange from a seller. Delivery may be immediate, but this depends on what is being traded.
Spot markets are also known as cash markets because traders make payments upfront. Spot markets may come in a variety of forms, and third parties that facilitate trading, known as exchanges, are typically present. You may also trade directly with other individuals in over-the-counter transactions (OTC). We will discuss these later.
What is spot trading?
Spot traders try to profit on the spot market by purchasing assets and hoping they will rise in value. When the price increases, they can sell their assets and make a profit. They can also sell short. This process involves selling financial assets and repurchasing more when the price declines.
You can purchase or sell your holdings at the spot price immediately using a market order on an exchange.
The spot price is the current market price for an asset. There is no guarantee that the market price won’t change while your order executes, nor that there will be enough volume to satisfy your order at the price you desire. If, for example, you wish to buy 10 ETH at the spot price, but only 3 are available, you will have to purchase the remaining ETH at a different price.
Spot prices update in real time and change as orders match up. With over-the-counter spot trading, you can secure a fixed amount and price directly from another party without an order book.
Delivery on any asset is either immediate or takes place within two business days of the trade date. Traditionally, shares and stocks were transferred using physical certificates. Foreign exchange markets previously sent currencies either through physical cash, wire, or deposit payments. Now, digital systems deliver almost immediately. However, crypto markets operate 24/7, allowing for quick trades. OTC trading might take longer to deliver, therefore.
Over-the-counter v.s. Exchanges
You can make spot trades in a number of different places, aside from exchanges. As mentioned, these transactions are referred to as over-the-counter trades. Each spot market has its own set of rules.
Centralised Exchange
There are two types of exchanges: centralised and decentralised. A centralised exchange handles the trading of assets like cryptocurrencies, forex, and commodities. As an intermediary between market participants and a custodian of the assets, a centralised exchange handles the trading of cryptocurrencies. To trade on a centralised exchange, you must first deposit your fiat or crypto funds.
The commissions exchanges charge for transactions, listings, and other trading activities are used to pay for regulatory compliance, KYC (Know Your Customer), fair pricing, security, and customer protection.
Transactions should occur smoothly on a serious exchange. Due to this, exchanges can profit in both bull and bear markets as long as they have sufficient users and trading volume.
Decentralised Exchange
A decentralised exchange, or DEX, is a type of exchange that matches buyers and sellers using blockchain technology rather than being controlled by a central institution.
DEXs provide the same basic services as a centralized exchange, but unlike centralized exchanges, they match buyers and sellers rather than simply matching orders. Users of DEXs typically do not need to create an account and may trade directly with one another without transferring assets to the exchange.
A DEX enables direct trading from the trader’s wallets through self-executing smart contracts on a blockchain. Many people prefer the DEX experience because it provides privacy and freedom in addition to standard exchanges. However, this comes at a cost. For example, lack of KYC and customer support may be a problem if you run into problems.
Some DEXs use an order book model, such as Binance DEX. A more recent development is the Automated Market Maker (AMM) model like Pancake Swap and Uniswap. AMMs rely on smart contracts but use a different pricing mechanism than those that are utilised in traditional markets. Buyers deposit their tokens in a liquidity pool and receive tokens in exchange, while liquidity providers offer the liquidity pool’s funds in exchange for a fee.
Over-the-counter
Spot trading in the OTC market uses multiple communication methods to organise trades, including phones and instant messaging. Brokers, traders, and dealers directly trade financial assets and securities on the other end.
Because OTC trades don’t require an order book, they have some advantages. When trading an illiquid asset like a small-cap coin, large orders can result in slippage. Because exchanges frequently cannot fill an order at the desired price, you must accept a higher price to finish the transaction, big OTC trades usually get better prices.
Large BTC orders can also benefit from OTC trades, as even liquid assets like BTC can experience slippage.
What are the distinctions between spot trading and margin trading?
Some spot markets allow for margin trading, but it is not the same as spot trading.
As we mentioned earlier, spot trading requires you to pay immediately for the asset and take delivery.
Margin trading, on the other hand, allows you to borrow money from a third party with interest and thus enter larger positions.
Because borrowing gives a margin trader more opportunities for substantial profits, it also increases the likelihood of major losses. However, the opposite is also true, so you should avoid losing all of your initial investment.
Pros and Cons of Spot Market
Every kind of trading and approach has its advantages and disadvantages. Knowing these will help you reduce jeopardy and trade more safely. Spot trading is one of the simpler ones, but it still has strengths and weaknesses.
Pros
- Prices are highly transparent and only depend on supply and demand in the market. This aspect contrasts with the futures market, which often contains multiple reference prices. For instance, the Binance futures market uses various other factors beyond supply and demand to determine the mark price, such as the funding rate, price index, and Moving Average (MA) Basis.
- Spot trading is easy to participate in because of its simple rules, rewards, and risks. You can easily calculate your risk when investing $500 on the spot market, based on your entry and the current price.
- You don’t have to worry about being liquidated or getting a margin call with spot trading. Unlike derivatives and margin trading, you don’t have to keep checking your investment unless you want to make short-term trades. You can enter or exit a trade whenever you want.
Cons
- Spot markets might prevent you from holding certain assets. Commodities are a good example. You would have to take physical possession of crude oil if you purchased it on the spot market. You will be responsible for safeguarding and securing tokens and coins if you trade futures derivatives. You might still get exposure to these assets, but you will pay for them.
- Certain individuals and corporations value stability. The forex market, for example, provides access to foreign currency for companies seeking to expand overseas. In the spot market, expenditures and incomes would be wildly unpredictable if relied upon for spending and revenue forecasts.
- When comparing spot trading to futures or margin trading, keep in mind that the potential gains are much smaller. You can leverage the same amount of capital to trade larger positions.
Final Thoughts
When you’re first starting out with spot trading, one of the most frequent techniques is spot trading in spot markets. It’s simple, but it’s always beneficial to know its advantages, disadvantages, and potential tactics. In addition to the fundamentals, you should combine your knowledge with sound technical, fundamental, and sentimental analysis.
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