What is Spot Forex Trading
January 2, 2017
The forex market consists of spot, futures and options market. The spot market is the interbank market, or the over the counter (OTC).
Spot trading and futures trading look like being similar, but there is a small difference, depending on the brokerage house type. Nevertheless, they are associated as being the same because the way trading is promoted.
By definition, spot forex trading is a contract that obligates two parties to trade a volume in a currency pair at a predetermined price. This is what an exchange rate is, and it represents the basic of forex trading.
The trader is not obligated to close a position, but he/she may bet that the currency will be cheaper (in the case of a short position) in the spot market sometime before the settlement date. For the forex market, the currency pairs are exchanged only following the settlement date.
When compared with other markets, spot trading in the Forex market is intended for immediate settling, namely the trade is completed by the time the buyer and the seller change hands. However, the physical delivery of the currencies will take more time, typically two business days.
For brokers that are market makers, the settlement takes place instantly because those brokers take both sides of the trade. This way, trades are being settled instantly and accounts updated accordingly.
Spot forex trading has been the preferred trading way for professionals for quite some time. The reason is the fact that spot forex trading is based on contracts bought and sold instantly with a strong effect on the actual price.
It is worth mentioning here the fact that prices are settled in cash. Because of this, the spot forex market is also called the “cash market”.
As explained above, the settlement of spot forex trading will take around two days, but in the futures market, this period can go all the way to a few months in the future or maybe even more. This makes the spot forex trading appealing.
There is a saying that around fifty percent of forex trades are settled within two days and almost all of them within two weeks. One should keep in mind that the forex market is the biggest one in the world and its growth is associated with the popularity among independent dealers and retail investors.
One important characteristic of the spot forex market is that spreads are higher when compared with the future market. This is a quick way to find out if your broker is a market maker or not.
However, the main characteristic of the spot forex market is the fact that brokers can offer micro-lots to their clients. This is not possible otherwise, and such characteristic appeals very much to the retail trader.