The term “spot” refers to the spot market, where financial instruments are bought and sold for immediate delivery.
In the financial world, different markets allow for various types of transactions.
Among these, the spot market holds a unique position as a place for immediate trading.
Let’s explore the concept of ‘spot’ and how it works.
Definition of Spot
The term “spot” in trading refers to the spot market, a market where financial instruments—be they commodities, securities, or currencies—are bought and sold for immediate delivery.
The term “spot” comes from the phrase “on the spot” – meaning “right now” or “on the spot”.
In other words, the exchange of cash for the actual asset happens ‘on the spot’.
The “spot price” is the current market price at which an asset is bought or sold for prompt delivery.
Spot Market in Forex Trading
For example, in the spot forex market, currencies are traded immediately or “on the spot” using the current market price.
If you buy EUR/USD, that means you buy the euro and sell the U.S.> dollar at the current exchange rate.
The settlement of this trade (exchange of currencies) happens almost instantaneously.However, in practice, the actual physical exchange of currencies in a spot forex trade usually takes two days and is known as T+2 settlement.
The “T” stands for the trade date (when the order is made) and “2” is the number of working days it takes for the trade to be settled.
Remember, even though the physical exchange of currencies takes two days, the terms of the trade (the rate of exchange) are agreed upon immediately, hence the term “spot”.
Spot vs. Futures and Forward Markets
The spot market stands in contrast to futures and forward markets, where the delivery of the asset and the payment occur at a future date.
In these markets, contracts are made based on predictions or agreements on what the price will be at a future date, known as the delivery date.
In a spot market transaction, however, both parties agree to the transaction based on the current market price, and the trade is settled ‘on the spot.’
It’s important to note that while the agreement and price are settled immediately, the physical delivery of the asset usually takes a little time.