Carefully! Lots of text.
Spot trading involves the direct purchase and sale of financial instruments and assets such as cryptocurrencies, forex, stocks and bonds. Delivery of the asset usually occurs immediately. Spot trading occurs in spot markets, which are either exchange-traded or over-the-counter (trading directly between traders). Trading spot markets uses only the assets you own—no leverage or margin.
Centralized spot trading exchanges monitor compliance, security, client assets (provide custodial services) and other factors, thereby facilitating trading. In exchange, exchanges charge transaction fees. Decentralized exchanges provide similar services, but using smart contracts on the blockchain.
Introduction
Spot trading is an easy way to invest and trade. When investing in cryptocurrency, you usually start with a spot transaction on the spot market, such as buying BNB at the market price and hodling it.
Spot markets exist for different asset classes, including cryptocurrencies, stocks, commodities, forex and bonds. Chances are you are more familiar with spot markets and spot trading than you think. Some of the most popular markets, such as NASDAQ and NYSE (New York Stock Exchange), are spot markets.
What is the spot market?
A spot market is a public financial market in which assets are traded instantly. The buyer buys an asset from the seller for fiat or another asset. Delivery usually occurs immediately, but depends on the asset being traded.
Spot markets are also known as cash markets because traders make payments upfront. There are different forms of spot markets, and trading in them is usually facilitated by third parties known as exchanges. You can also trade directly with other traders through over-the-counter (OTC) trades. We'll look at this in more detail next.
What is spot trading?
Spot traders seek to make a profit in the market by purchasing assets with the expectation that their prices will rise. When the price of the asset rises, they will be able to sell the asset for a profit. Spot traders can also short the market. Shorting involves selling financial assets and repurchasing them when prices fall.
The current market price of an asset is called the spot price. With a market order on an exchange, you can buy or sell assets at the best available spot price. However, there is always a risk that the market price will change during the execution of the order. In addition, there may not be enough volume to execute the order at the desired price. For example, if you place an order for 10 ETH at the spot price, but there is only 3 ETH on the market at that price, the rest of the order will be filled at a different price.
Spot prices are updated in real time and change as orders are matched. Over-the-counter spot trading works differently: a trader can receive a fixed amount at a fixed price directly from another party without an order book.
Depending on the asset, delivery may be immediate or within T+2 days. T+2 means the current date plus two business days. Historically, shares and capital required the transfer of physical certificates, while forex currencies were transferred in cash, bank transfer or deposit. Now, thanks to electronic systems, delivery is carried out almost instantly. Cryptocurrency markets operate 24 hours a day, allowing you to make instant transactions at any time. At the same time, with over-the-counter or peer-to-peer trading, delivery times increase.
Exchanges and over-the-counter trading
Spot trading is not limited to any specific location. Although most people spot trade on exchanges, it is also possible to trade directly with other traders without the involvement of a third party. As we have already said, these sales and purchases are known as over-the-counter transactions. Each spot market is different.
Centralized exchanges
There are two types of exchanges: centralized and decentralized. The centralized exchange manages the trading of assets, including cryptocurrency, forex and commodities. The exchange acts as an intermediary between market participants and the custodian of traded assets. To use a centralized exchange, you need to transfer fiat or cryptocurrencies to your account for trading.
A large centralized exchange must ensure continuous transactions. It also ensures compliance with regulatory requirements, user KYC (Know Your Customer) verification, and fair pricing, security, and customer protection. In exchange, the exchange charges fees for transactions, listings, and other trading activities. Due to its large number of users and trading volume, the exchange generates fee income during both bull and bear markets.
Decentralized exchanges
Decentralized exchanges (DEX) are another common type of exchange for dealing with cryptocurrencies. DEXs offer most of the services available on centralized exchanges. The main difference is that DEX matches buy and sell orders using blockchain technology. Typically, DEX users do not need to create accounts and can trade freely with each other without transferring assets to the DEX.
Trading is carried out directly between traders' wallets through smart contracts - self-executing code fragments on the blockchain. Many users prefer DEX over regular exchanges due to greater privacy and freedom. However, these benefits come at a price: if problems arise, the lack of KYC and customer support will be a big disadvantage.
Some DEXs use an order book model, such as Binance DEX. There is also a newer model of automated market maker (AMM) 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 swap tokens. And liquidity providers that provide funds to the pool charge transaction fees from pool users.
OTC trading
On the other hand, there is over-the-counter or off-exchange trading. In this case, trading of financial assets and securities is carried out directly between brokers, traders and dealers. Spot trading in the over-the-counter market uses a variety of communication methods to arrange trades, including telephones and instant messaging.
Over-the-counter trading has a number of advantages due to the absence of an order book. If you are trading assets with low liquidity, such as small cap coins, a large order may cause slippage. Often the exchange cannot fully fill the order at the expected price, so a less favorable price will have to be accepted to fill the remainder. For this reason, large trades in over-the-counter trading are often carried out at better prices.
Please note that even liquid assets such as BTC can experience slippage if orders are too large. Thus, large BTC orders also come with greater benefits in over-the-counter trades.
What is the difference between spot and futures markets?
We've already talked about how spot markets involve instant transactions with near-instant delivery. In contrast, in the futures market, contracts settle later. The buyer and seller agree to exchange a certain quantity of goods at a predetermined price in the future. In cases where the contract expires on the settlement date, the buyer and seller usually settle in cash rather than deliver the asset.
More information about futures in our article What are forward and futures contracts.
What is the difference between spot and futures trading?
Margin trading is available in some spot markets, but it is not the same as spot trading. As mentioned, spot trading means that you immediately purchase the asset in full and receive it immediately. In contrast, margin trading allows you to borrow funds at interest from a third party, which allows you to open larger positions. Thus, borrowing gives the margin trader the opportunity to make larger profits. However, it also increases the potential for losses, so special care must be taken to avoid losing your initial investment.
How to Start Spot Trading on Binance
Spot trading on Binance is quite simple and only requires registering an account on Binance. Let's take a look at the Binance exchange interface and learn how to make a spot trade. To go to the trading platform, open the Binance home page, hover over the “Trading” section and select “Spot”.
Next, you will see a trading interface with several sections.
1. At the top of the page are cryptocurrency trading pairs and other market information, including daily price changes and volume.
2. The order book lists and orders by price all open orders to buy and sell an asset. Green orders are buy orders, and red orders are sell orders. When you place a market order to buy an asset, you choose the lowest price offered. If there is not enough volume to fill your order, the next minimum ask price will be used.
3. The following is a chart with customizable historical price data. Integration with TradingView allows you to use a wide range of technical analysis tools.
4. In the upper right corner there is a search window for trading pairs. This option allows you to select a cryptocurrency pair to trade on the spot market, as well as mark your favorite pairs by clicking on the star icon. Cryptocurrency does not have to be purchased for fiat - if you have other cryptocurrencies, they can be exchanged for the desired coins and tokens on the spot market.
5. In this section, a buy or sell order is created. We are now on the Spot tab. Here you can choose between Limit, Market and Stop Limit orders.
Let's look at the simplest spot trade you can make: a market order. Let's say you want to buy $1000 worth of Bitcoin (BTC) (BUSD). To do this, enter 1000 in the “Total” field and click “Buy BTC”. The exchange will immediately transfer BUSD to the seller, and you will receive $1000 worth of BTC (BUSD).
Advantages and Disadvantages of Spot Markets
Every type of trading and strategy you encounter has its own advantages and disadvantages. Understanding this will help you reduce your risks and trade with more confidence. Spot trading is one of the simplest, but it also has strengths and weaknesses.
Advantages of spot markets
1. Prices are transparent and regulated only by supply and demand in the market. This is a significant difference between the spot market and the futures market, which contains several reference prices. For example, the Binance futures mark price is calculated from a combination of information including the funding rate, price index, and underlying moving average. In some traditional markets, interest rates may also affect mark prices.
2. Spot trading is attractive due to the simplicity of its 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.
3. You can “set it and forget it.” Unlike derivatives and margin trading, with spot trading traders do not have to worry about liquidation or margin calls. Spot trading makes it easy to enter and exit a position at any time. If you don't intend to make short-term trades, you won't have to worry about the amount of funds available.
Disadvantages of Spot Markets
1. Depending on what you trade, spot markets may leave you with assets that are not comfortable to hold. Perhaps the best example is products. If you buy crude oil on the spot market, you will have to take physical delivery of the asset. In the case of cryptocurrencies, storing tokens and coins makes you responsible for their security. By trading futures derivatives, you can also gain exposure to these assets but settle in cash.
2. The need for stability for some assets, individuals and companies. For example, a company wishing to operate abroad needs access to foreign currency in the foreign exchange market. If it relies on the spot market, cost and income planning will be extremely unsustainable.
3. The potential profit from spot trading is much less than from futures and margin trading. In the futures and margin markets, you can use the same amount of capital to trade larger positions.
Summary
Trading spot markets is one of the most common ways of trading, especially for new traders. While trading the spot market may seem simple, it never hurts to know its advantages, disadvantages, and potential strategies. In addition to knowing the basics, you should consider learning about technical analysis, fundamental analysis, and market sentiment analysis.
