What Is the Spot Market & How Does It Work?
A spot market is a market where buyers meet sellers and make an immediate exchange. In other words, delivery takes place at the same time payment is made. That can include stock exchanges, currency markets, or commodity markets.
But often when discussing spot markets, we’re talking about commodities. Commodity markets are somewhat different from the markets for stocks, bonds, mutual funds, and ETFs, all of which trade exclusively through brokerages. Because they represent a physical good, commodities have an additional market — the spot market. This market represents a place where the actual commodity gets bought and sold right away.
Key Points
• Spot markets involve instant trades and immediate delivery.
• Spot prices reflect real-time supply and demand.
• Spot markets are less susceptible to manipulation.
• OTC and centralized exchanges facilitate spot trades.
• Futures markets are speculative, while spot markets are organic.
Spot Markets Definition
If you’re trying to define the spot markets, it may be helpful to think of it as a public financial market, and one on which assets or commodities are bought and sold. They’re also bought and sold for immediate, or quick, delivery. That is, the asset being traded changes hands on the spot.
Prices quoted on spot markets are called the spot price, accordingly.
One example of a spot market is a coin shop where an individual investor goes to buy a gold or silver coin. The prices would be determined by supply and demand. The goods would be delivered upon receipt of payment.
Understanding Spot Markets
Spot markets aren’t all that difficult to understand from a theoretical standpoint. There can be a spot market for just about anything, though they’re often discussed in relation to commodities (perhaps coffee, corn, or construction materials), and specific things like precious metals.
But again, an important part of spot market transactions is that trades take place on the spot — immediately.
Which Types of Assets Can Be Found on Spot Markets?
As noted, all sorts of assets can be found on spot markets. That ranges from food items or other consumables, construction materials, precious metals, and more. If you were, for instance, interested in investing in agriculture from the sense you wanted to trade contracts for oranges or bananas, you could likely do so on the spot market.
Some financial instruments may also be traded on spot markets, such as Treasuries or bonds.
How Spot Market Trades Are Made
In a broad sense, spot market trades occur like trades in any other market. Buyers and sellers come together, a price is determined by supply and demand, and trades are executed — usually digitally, like most things these days. In fact, a spot market may and often does operate like the stock market.
As noted, stock markets are also, in fact, spot markets, with financial securities trading hands instantly (in most cases).
💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.
What Does the Spot Price Mean?
As mentioned, the spot price simply refers to the price at which a commodity can be bought or sold in real time, or “on the spot.” This is the price an individual investor will pay for something if they want it right now without having to wait until some future date.
Because of this dynamic, spot markets are thought to reflect genuine supply and demand to a high degree.
The interplay of real supply and demand leads to constantly fluctuating spot prices. When supply tightens or demand rises, prices tend to go up, and when supply increases or demand falls, prices tend to go down.
The Significance of a Spot Market
The spot market of any asset holds special significance in terms of price discovery. It’s thought to be a more honest assessment of economic reality.
The reason is that spot markets tend to be more reliant on real buyers and sellers, and therefore should more accurately reflect current supply and demand than futures markets (which are based on speculation and can be manipulated, as recent legal cases have shown. More on this later.)
Types of Spot Markets
There’s only one type of spot market — the type where delivery of an asset takes place right away. There are two ways this can happen, however. The delivery can take place through a centralized exchange, or the trade can happen over the counter.
Over-the-counter
Over-the counter, or OTC trades, are negotiated between two parties, like the example of buying coins at a coin shop.
Market Exchanges
There are different spot markets for different commodities, and some of them work slightly differently than others.
The spot market for oil, for example, also has buyers and sellers, but a barrel of oil can’t be bought at a local shop. The same goes for some industrial metals like steel and aluminum, which are bought and sold in much higher quantities than silver and gold.
Agricultural commodities like soy, wheat, and corn also have spot markets as well as futures markets.
Spot Market vs Futures Market
One instance that makes clear the difference between a spot market and a futures market is the price of precious metals.
Gold, silver, platinum, and palladium all have their own spot markets and futures markets. When investors check the price of gold on a mainstream financial news network, they are likely going to see the COMEX futures price.
COMEX is short for the Commodity Exchange Inc., a division of the New York Mercantile Exchange. As the largest metals futures market in the world, COMEX handles most related futures contracts.
These contracts are speculatory in nature — traders are making bets on what the price of a commodity will be at some point. Contracts can be bought and sold for specific prices on specific dates.
Most of the contracts are never delivered upon, meaning they don’t involve delivery of the actual underlying commodity, such as gold or silver. Instead, what gets exchanged is a contract or agreement allowing for the potential delivery of a certain amount of metal for a certain price on a certain date.
For the most part, futures trading only has two purposes: hedging bets and speculating for profits. Sophisticated traders sometimes use futures to hedge their bets, meaning they purchase futures that will wind up minimizing their losses in another bet if it doesn’t go their way. And investors of all experience levels can use futures to try to profit from future price action of an asset. Predicting the exact price of something in the future can be difficult and carries high risk.
The spot market works in a different manner entirely. There are no contracts to buy or sell and no future prices to consider. The market is simply determined by what one party is willing to purchase something for.
|
Spot Market vs Futures Market |
|
|---|---|
| Spot Market | Futures Market |
| No contracts to buy or sell | Contracts are bought and sold outlining future prices |
| Trades occur instantly | Trades may never actually occur at all |
| Non-speculative | Speculative by nature |
Another important concept to understand is contango and backwardation, which are ways to characterize the state of futures markets based on the relationship between spot and future prices. Some background knowledge on those concepts can help guide your investing strategy.
Note, too, that some investors may be confused by the concepts of margin trading and futures contracts. Margin and futures are two different concepts, and don’t necessarily overlap.
💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.
Example of a Spot Market
Consider the spot and futures markets for precious metals.
Precious-metal prices that investors see on financial news networks will most often be the current futures price as determined by COMEX. This market price is easy to quote. It’s the sum of all futures trading happening on one central exchange or just a few central exchanges.
The spot market is more difficult to pin down. In this case, the spot market could be generally referred to as the average price that a person would be willing to pay for a single ounce of gold or silver, not including any premiums charged by sellers.
Sometimes there is a difference between prices in the futures market and spot market. The difference is referred to as the “spread.” Under ordinary circumstances, the difference will be modest. During times of uncertainty, though, the spread can become extreme.
Futures Market Manipulation
As for trying to define what spot price means, it’s important to include one final note on futures markets. This will illustrate a key difference between the two markets.
Recent high-profile cases brought by government enforcement agencies like the Securities and Exchange Commission and Commodities and Futures Trading Commission highlight the susceptibility of futures markets to manipulation.
Some large financial institutions have been convicted of engaging in practices that artificially influence the price of futures contracts. Again, we can turn to the precious-metals markets for an example.
During the third quarter of 2020, JP Morgan was fined $920 million for “spoofing” trades and market manipulation in the precious metals and U.S. Treasury futures markets. Spoofing involves creating large numbers of buy or sell orders with no intention of fulfilling the orders.
Because order book information is publicly available, traders can see these orders, and may act on the perception that big buying or selling pressure is coming down the pike. If many sell orders are on the books, traders may sell, hoping to get ahead of the trade before prices fall. If many buy orders are on the books, traders may buy, thinking the price is going to rise soon.
Cases like this show that futures markets can be heavily influenced by market participants with the means to do so.
Spot markets, on the other hand, are much more organic and more difficult to manipulate.
3 Tips for Spot Market Investing
For those interested in trying their hand in the spot market, here are a few things to keep in mind.
1. Know What’s Going On
Often, prices in the spot market can change or be volatile in relation to the news or other current events. For that reason, it’s important that investors know what’s happening in the world, and use that to assess what’s happening with prices for a given asset or commodity.
2. Keep Your Emotions in Check
Emotional investing or trading is a good way to get yourself into financial trouble, be it in the spot market, or any other type of trading or investing. You’d likely do well to keep your emotions in check when trading or investing on the spot market, as a result.
3. Understand the Market
It’s also a good idea to do some homework and make a solid attempt at trying to understand the market you’re trading in. There may be jargon to learn, terms to understand, price discovery mechanisms that could otherwise be foreign to even a seasoned investor — do your best to do your due diligence.
The Takeaway
Spot markets are where commodities are traded, instantly. There are numerous types of spot markets, and there are numerous types of commodities that might be traded on them. Investors would be wise to know the basics of how they work, and come armed with a bit of background knowledge about the given commodity they’re trading, in order to reach their goals.
Spot market trading can be a part of an overall trading strategy, but again, investors should know the ropes a bit before getting in over their heads. It may be a good idea to speak with a financial professional before investing.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
What is spot market vs a futures market?
Trades on a spot market occur instantly, on the spot. Trades in the futures market involve contracts for commodities with prices outlined for some time in the future — if they occur at all.
What does spot market mean?
The term spot market refers to a financial market where assets or commodities are bought and sold by traders. The trades occur on the spot, or instantly, for immediate delivery.
What is the difference between spot market and forward market?
Forward markets involve trading of futures contracts, or transactions that take place at some point in the future, whereas spot market trades occur instantly, often for cash.
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