TL;DR
Spot trading involves buying or selling financial instruments and assets such as cryptocurrencies, forex, stocks or bonds directly. Delivery of the assets is often immediate. Spot trading occurs on exchange-based or over-the-counter (directly between traders) spot markets. When trading on the spot market, you can only use the assets you own - there is no leverage or margin.
Centralized exchanges for spot trading manage regulatory compliance, security, custody, and other factors to make trading easier. In return, exchanges charge transaction fees. Decentralized exchanges provide similar services, but through blockchain smart contracts.
Introduction
Spot trading offers a simple way to invest and trade. In crypto investing, your first experience will likely be spot transactions on the spot market. For example, buying BNB at market price and doing HODLing.
There are spot markets for various asset classes, including cryptocurrencies, stocks, commodities, forex and bonds. You may be more familiar with the spot market and spot trading than you think. Some of the most popular markets, such as NASDAQ or NYSE (New York Stock Exchange), are spot markets.
What is the spot market?
The spot market is a financial market open to the public where assets are traded immediately. Buyers purchase assets with fiat or other exchange media from sellers. Delivery of assets is often immediate, but this depends on the asset being traded.
The spot market is also known as the cash market, because traders make payments up front. Spot markets come in many forms and third parties known as exchanges usually facilitate trading. You can also trade directly with others in over-the-counter (OTC) trading. We'll get to that later.
What is spot trading?
Spot traders try to make a profit in the market by buying assets and hoping that their value will rise. They can sell the asset at a future date in the spot market at a profit when the price increases. Spot traders can also choose to short against the market. This process involves selling a financial asset and repurchasing it for a larger amount when its price falls.
The current market price of an asset is referred to as the spot price. By using a market order on an exchange, you can buy or sell holdings immediately at the best available spot price. However, there is no guarantee that the market price will not change while the order is executed. There is also the possibility that volume will not be sufficient to fill orders at the desired price. For example, if your order is for 10 ETH at the spot price but there are only 3 offered, you will need to fill the remainder of the order with ETH at a different price.
Spot prices are updated in real-time and change as orders are matched. Over-the-counter spot trading works differently. You can secure fixed quantities and prices directly from other parties without an order book.
Depending on the asset, delivery can be immediate or typically within T+2 days. T+2 is the trade date plus two business days. Traditionally, shares and equity require the transfer of a physical certificate. The foreign exchange market also previously transferred currency via cash, accounts or deposits. Now, delivery happens almost immediately with digital systems. However, the crypto market operates 24/7 allowing for trades that are usually instant. However, Peer-to-Peer or OTC trading can take longer for delivery.
Bursa vs. over-the-counter
Spot trading is not just limited to one place. Although most individuals will place spot trades on exchanges, you can also trade directly with other traders without the presence of a third party. As mentioned, these sales and purchases are referred to as over-the-counter trading. Each spot market has its own differences.
Centralized exchange
Exchanges come in two forms: centralized and decentralized. Centralized exchanges manage the trading of assets such as cryptocurrencies, forex and commodities. Exchanges function as intermediaries between market participants and as custodians for traded assets. To use a centralized exchange, you must fund your account with the fiat or crypto you want to trade.
A serious centralized exchange needs to ensure that transactions run smoothly. Other responsibilities include regulatory compliance, KYC (Know Your Customer), fair pricing, security and customer protection. In return, these exchanges charge fees on transactions, listings, and other trading activities. Because of this, exchanges can profit in both bull and bear markets as long as there are enough users and trading volume.
Decentralized exchange
Decentralized exchanges (DEX) are another type of exchange most commonly found in the crypto world. DEXs offer many of the same basic services as centralized exchanges. However, DEX matches buy and sell orders through the use of blockchain technology. In most cases, DEX users do not need to create an account and can trade directly with each other without having to transfer assets to the DEX.
Trading occurs directly from the trader's wallet via smart contracts. These contracts are pieces of code that execute themselves on a blockchain. Most users like the experience in DEXs because they provide more privacy and freedom than standard exchanges. However, there are tradeoffs to this. For example, a lack of KYC and customer support can make things difficult when you run into problems.
Some DEXs use an order book model, such as Binance DEX. The most recent developments are the Automated Market Maker (AMM) models, such as PancakeSwap and Uniswap. AMM also uses smart contracts, but applies a different model to determine prices. Buyers use funds in the liquidity pool to swap their tokens. Liquidity providers who provide pool funds charge transaction fees for anyone using the pool.
Over-the-counter
On the other hand, there is over-the-counter trading which is sometimes referred to as off-exchange trading. Financial assets and securities are traded directly between brokers, traders and dealers. Spot trading in the OTC market uses several communication methods to arrange trades, including telephone and instant messaging.
OTC trading benefits quite a bit from not requiring an order book. If you trade assets with low liquidity, such as small-cap coins, then large deep orders cause slippage. Exchanges are often unable to fulfill your order in full at the desired price. So, you need to take a higher price to complete the order. In this case, OTC trades often get better prices.
Be aware that even liquid assets like BTC can experience slippage when orders become too large. So, large BTC orders can also benefit from OTC trading.
What is the difference between the spot market and the futures market?
We have already discussed that the spot market performs instant trading with almost immediate delivery. On the other hand, the futures market has contracts that pay out on a date in the future. Buyers and sellers agree to trade a certain amount of goods at a certain price in the future. When the contract matures on the settlement date, the buyer and seller usually choose cash settlement rather than sending the asset.
For more information about futures, read Explanation of Forward Contracts and Futures.
What is the difference between spot trading and margin trading?
Margin trading is available in some spot markets, but it is not the same as spot trading. As mentioned previously, spot trading requires you to purchase the asset in full immediately and take delivery. In contrast, Margin trading allows you to borrow funds at interest from a third party, thereby allowing you to take larger positions. That way, borrowing will provide margin traders with more significant profit potential. However, this will also increase losses. So, you have to be careful not to lose all the initial funds.
How to trade spot on Binance
Spot trading on Binance is a simple process once you register for a Binance account. Let's take a look at the Binance exchange display and explore how to do spot trading. You can find the Spot trading platform by navigating to [Trade], then clicking [Spot] on the Binance home page.
You will now see a trading view containing various important sections.
1. At the top, you can see cryptocurrency trading pairs and other market information, such as daily price and volume changes.
2. The order book lists all open buy and sell orders of an asset organized by price. Green orders are buy orders and red ones are sell orders. When placing a market order to buy an asset, you take the lowest price offered. If more volume still needs to be filled, your order will move up to the next lowest ask price.
3. Here, you will see a chart view with customizable historical price data. TradingView is an internal component within windows that provides a variety of technical analysis tools that can be used.
4. In the top right corner, you can search for various trading pairs. Here, you can select the cryptocurrency pairs you want to trade on the spot market as well as mark your favorite pairs by clicking on the little star. Note that you do not have to buy cryptocurrency with fiat. If you have other currencies, you can also exchange them for other coins and tokens on the spot market.
5. This section is where you place a buy or sell order. You can see that the current section is [Spot]. Below that, you can choose between [Limit], [Market], and [Stop-limit] orders.
Let's take a look at the easiest spot trade that can be done: a market order. In our example, you want to buy $1,000 (BUSD) worth of bitcoin (BTC). To do this, you simply enter 1,000 into the [Total] field and then click [Buy BTC]. The exchange will send BUSD immediately to the seller and you will receive $1,000 worth of BTC (BUSD).
Advantages and disadvantages of the spot market
Each type of trading and strategy you will encounter has advantages and disadvantages. By understanding them, you can reduce risk and trade with more confidence. Spot trading is one of the simpler types, but it still has its strengths and weaknesses.
Advantages of the spot market
1. Prices are transparent and only rely on demand and supply in the market. This aspect is in contrast to futures markets which often have multiple reference prices. For example, mark prices in the Binance futures market are derived from other information, including funding rates, price indexes, and the underlying Moving Average (MA). In some traditional markets, mark prices can also be influenced by interest rates.
2. Spot trading is easy to do because the rules, rewards and risks are simple. When investing $500 in the spot market in BNB, you can easily calculate the risk based on the entry price and the current price.
3. You can “set it and forget it.” Unlike with derivatives and margin trading, you don't have to worry about getting liquidated or getting a margin call with spot trading. You can enter or exit a trade whenever you wish. You also don't need to keep checking investments, unless you want to make short-term trades.
Disadvantages of spot markets
1. Depending on the asset being traded, the spot market may provide assets that are not convenient to own. Commodities are perhaps the best example. If you buy crude oil spot, you must take physical delivery of the asset. With cryptocurrencies, owning tokens and coins puts the responsibility on you to keep them safe. By trading futures derivatives, you can still gain exposure to these assets but settle in cash.
2. For certain assets, individuals and companies, stability is valuable. For example, companies wishing to operate abroad need access to foreign currency in the forex market. If they rely on the spot market, spending and income planning will become very unstable.
3. The potential profit in spot trading is much less than in futures or margin trading. You can utilize the same amount of capital to trade larger positions.
Closing
Spot trading on the spot market is one of the most common ways for people to trade, especially beginners. Even though it is easy, it is always better to have more knowledge about the advantages, disadvantages, and potential of the strategy. Apart from the basics, you should try to combine your knowledge with trusted technical analysis, fundamentals and sentiment.
