What is spot trading: definition and opportunities
what is spot trading
IN A FEW WORDS
Spot tradingMain spot marketsTrading
7 min reading
Spot trading: the definitive guide
Spot trading, or spot contract trading, is the normal type of trading that is done during market hours when an asset is bought for the spot price, which is the current price of the asset based on the bid and asks prices of the potential buyers and sellers.
The spot date, when the trade is actually settled, usually occurs 1-2 business days after the trade has been conducted, and the funds are exchanged for the asset on that date. Until that date, the funds for the trade are not considered “settled”, and thus cannot be used for other trades and cannot be withdrawn from the trading account. Of course, in the case of buying, the assets purchased by the spot trade can still be sold before the spot date (as with “day trading”).
Spot trading and cash accounts
Accounts that are restricted to only spot trading are essentially “cash” accounts. In this case, trades can only be made with the settled portions of the funds in them. Thus if the account holder makes large volumes of trades that use most of their trading capital, they will have to periodically wait for the funds to settle. These pure cash accounts are usually recommended (or sometimes required) for beginning retail investors without much trading experience or for retail traders that are seen to be too high risk to use borrowed money to make trades in case of loss and/or default.
Spot trading vs derivatives trading
Spot trading is distinguished from derivatives trading, like futures contract trading, where the trader does not receive the underlying assets until some point in the future. This is because spot trades rely only on the current price of the asset at the transaction date, where futures rely on both the current price when the contract is taken out as well as the prices at a future date or future dates when the contract is sold or is exercised.
Accounts that are restricted to spot trading (cash account) are distinguished from margin accounts (where money can be borrowed in the short or long term to make trades and/or hold positions of greater value than the funds balance) as well as spread betting or CFD accounts.
When opening one of these types of accounts at a brokerage, the brokerage will often take into account the trader’s income and experience level when deciding whether to restrict the trader to spot trading or whether to allow them access to more complex trading and brokerage products like spread bets and CFDs.
Main spot markets
Commodities trades, however, are unlike many other spot trades since the trader does not have access to the commodity at the time of the trade or settlement, nor are the commodities usually taken possession of by the buyers.
Instead, these trades rely on future settlement as the commodities contracts are bought and sold unless the contract matures in the trader’s possession, in which case the trader would have to arrange for the commodities’ delivery and storage.
Market’s use of spot dates
All types of trades have the use of spot dates in common since settlement dates are always later than trade dates.
However, there are differences in markets’ use of spot dates across asset classes. As noted above, spot trades will have spot dates 1-2 days after the trade, and derivatives like futures and options will have spot dates at the contract’s expiration/maturity date (for whoever is holding the contract).
On the last day of trading for an options or futures contract, the trader’s account will be on record at the close of the market to receive or have deducted the appropriate balance of the contract.
But contracts like forwards or foreign exchange swaps are not like this, instead of having actual cash settlement much later than the spot date (perhaps a month later). Contracts like these are over-the-counter (OTC), less regulated, with less transparency and more risks, and are settled in a broker network (between the broker and the contract holder); whereas non-OTC equities and all options are settled through regulated exchanges. Financial products like these are less subject to regulations regarding when cash settlement is required, like mandates for T+2 or T+3 (2 or 3 business days after the trade) spot dates.
Spot trading account: advantages
The advantage of only having a spot trading account is that it artificially limits position sizing to non-leveraged positions.
This is quite helpful for beginning investors or investors holding long positions for long periods of time as it can help their portfolio survive market headwinds or catastrophic market events. Margin accounts with highly leveraged positions that are not limited in this way must take greater caution to ensure their solvency. New investors who learn investing through spot trading will be much more likely to survive their learning experiences.
Information or views expressed should not be taken as any kind of recommendation or forecast. All trading involves risks, losses can exceed deposits.
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