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What is a spot market?




Spot trading involves the direct purchase and sale of various financial instruments and assets, such as cryptocurrencies, forex, stocks, and bonds, with the delivery of the asset typically taking place immediately. This type of trading occurs on spot markets, which can be either exchange-traded or over-the-counter (where traders trade directly with each other). It is important to note that in spot market trading, only assets that you own are used, without the use of leverage or margin.


Centralized exchanges for spot trading are responsible for compliance with regulatory requirements, security, client assets (providing custody services), and other important factors, facilitating the trading process. In exchange for the services provided, exchanges charge commissions for each transaction. Decentralized exchanges also provide similar services but utilize blockchain smart contracts for this purpose.


Introduction


Spot trading is a convenient and straightforward way to invest and trade in financial markets. Typically, when investing in cryptocurrencies, you start by making a spot transaction on a spot market, such as buying BNB at the current market price and holding it in your portfolio.


Spot markets are designed for trading various classes of assets, including cryptocurrencies, stocks, commodities, forex, and bonds. You are probably more familiar with spot trading and spot markets than you might think.


What is a spot market?


A spot market is an open financial market where assets are traded immediately. In this process, the buyer purchases the asset from the seller for cash or another asset. The delivery time may vary depending on the asset being traded.

Spot markets are also known as cash markets because traders make payments upfront. There are several forms of spot markets, and usually third parties, such as exchanges, facilitate trading on these markets. It is also possible to conduct transactions directly with other traders through over-the-counter (OTC) deals. We will discuss this in more detail below.


What is spot trading?


Spot traders aim to profit in the market by buying assets with the expectation of their price increasing. When the price of the asset rises, they can sell the asset at a profit. Spot traders can also short the market, which involves buying financial assets and selling them when the price increases.

The current market price of an asset is known as the spot price. To buy or sell assets at the best available spot price, you can use a market order on an exchange. However, there is always a risk of the market price changing when the order is executed. Additionally, it may turn out that the volume at the desired price in the market is insufficient, so the remaining part of the order will be executed at a different price.

Spot prices are constantly updated in real-time and change when orders match. Over-the-counter spot trading works differently: a trader may receive a fixed amount at a fixed price directly from another party without an order book.


Exchanges and Over-the-Counter Trading


Spot trading is not tied to a specific location. While most people engage in spot trading on exchanges, there is the option to trade directly with other traders without the involvement of a third party. As we mentioned earlier, such sales and purchases are called over-the-counter (OTC) deals. Each spot market has its own characteristics.


Centralized Exchanges


There are two types of exchanges in the market - centralized and decentralized. A centralized exchange manages the trading of assets such as cryptocurrency, forex, and commodities. Acting as an intermediary between market participants and the custodian of traded assets, it processes transactions. To use a centralized exchange, fiat or cryptocurrency must be transferred to the account.

A major centralized exchange must ensure seamless transaction execution and compliance with regulatory requirements, including KYC verification and ensuring fair pricing, security, and customer protection. The exchange generates revenue from transaction fees, listings, and other trading activities, thanks to a large user base and high trading volume.


Decentralized Exchanges


Decentralized exchanges (DEX) are a popular type of exchange for dealing with cryptocurrencies. DEX provides most of the services available on centralized exchanges. However, the main difference is that DEX matches buy and sell orders using blockchain technology. Typically, DEX users do not need to create accounts, and they can freely trade with each other without transferring assets to the DEX.

Trading takes place directly between traders' wallets using smart contracts - self-executing pieces of code on the blockchain. Many users prefer DEX over regular exchanges for greater privacy and freedom. However, these advantages come at a cost: in case of issues, the lack of KYC and customer support can be a significant drawback.

Some DEXs use the order book model, such as Binance DEX. There is also a newer automated market maker (AMM) model, which is used in PancakeSwap and Uniswap. AMM also uses smart contracts but with a different model for determining prices. Buyers use funds from the liquidity pool to exchange tokens, and liquidity providers, who provide funds to the pool, charge transaction fees.


Over-the-Counter Trading


On the other hand, there is over-the-counter (OTC) trading. In this case, trading of financial assets and securities takes place directly between brokers, traders, and dealers. Spot trading on the OTC market involves various communication methods for organizing deals, including phones and instant messaging.


The advantages of OTC trading are associated with the absence of an order book. In the case of trading assets with low liquidity, such as low-cap coins, a large order can cause slippage. The exchange may not always be able to fully execute the order at the expected price, so a less favorable price may need to be accepted to fulfill the remaining portion.


OTC deals have some advantages due to the absence of the need to use an order book. If you are trading an asset with low liquidity, such as small coins, a large order can lead to slippage. The exchange often cannot fully execute your order at the desired price, so you end up taking higher prices to fulfill the order. For this reason, large OTC deals often have better prices. Note that even liquid assets like BTC can experience slippage if orders are too large. Therefore, large BTC orders can also benefit from OTC trading.


Difference Between Spot and Futures Markets


As mentioned earlier, spot markets involve instant transactions with almost immediate delivery. In contrast, contracts on the futures market are settled later. The buyer and seller agree to exchange a certain quantity of goods at a predetermined price in the future. When the contract expires, the buyer and seller usually settle in cash instead of delivering the asset.


Advantages and Disadvantages of Spot Markets


Each type of trading and strategy has its own advantages and disadvantages, which should be understood to reduce risks and trade more confidently. Spot trading is one of the simplest, but it also has its strengths and weaknesses.


Advantages of spot markets:


  • Spot market prices are transparent and regulated solely by supply and demand in the market. This sets spot markets apart from futures markets, where there are several reference prices. For example, the Binance futures mark price is calculated based on the funding rate, price index, and basis moving average. Interest rates on some traditional markets can also influence the mark price.

  • Spot trading is attractive for its simple rules, expected rewards, and risks. If you invest $500 in BNB on the spot market, you can easily calculate your risk based on the entry price and the current price.

  • In spot trading, you can "set and forget". When trading on spot markets, traders don't have to worry about liquidation or margin calls. Spot trading allows for easy entry and exit from positions at any time. If you're not planning to make short-term trades, you don't have to worry about the available funds.


Disadvantages of Spot Markets


  • Some assets, individuals, and companies require stability. For example, companies wishing to operate abroad need access to foreign currency in the forex market. If they rely on the spot market, planning expenses and revenues can be extremely unstable.

  • The potential profit from spot trading is much lower than that from futures and margin trading. In futures and margin markets, you can use the same amount of capital to trade larger positions.

  • Depending on what you trade, spot markets can leave you with assets that are inconvenient to hold. Commodities are perhaps the best example. If you buy crude oil on the spot, you'll have to take physical delivery of the asset. As for cryptocurrencies, owning tokens and coins imposes responsibility for their safekeeping and security. By trading futures derivatives, you can gain access to these assets while settling in cash.


Summary


Spot market trading is one of the most common trading methods, especially for novice traders. Although spot market trading may seem simple, it never hurts to know its advantages, disadvantages, and potential strategies. In addition to understanding the basics, consider studying technical analysis, fundamental analysis, and market sentiment analysis.


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