TL;DR
Spot trading involves the direct buying or selling of financial instruments and assets such as cryptocurrencies, forex, stocks or bonds. Delivery of the asset is usually immediate. Spot trading takes place in spot markets, which are based on exchanges (brokers) or over-the-counter markets (direct trading between traders). When trading on spot markets, you can only use your own assets - there is no leverage or margin.
Centralized exchanges manage regulatory compliance, security, custody, and other factors to facilitate spot trading. In return, exchanges charge transaction fees. Decentralized exchanges provide a similar service but through blockchain smart contracts.
Introduction
Spot trading offers a simple way to invest and trade. When investing in cryptocurrencies, your first experience will likely be a spot market transaction. For example, a purchase of BNB at market price and HODLing.
There are spot markets for different asset classes, including cryptocurrencies, stocks, commodities, forex and bonds. You're probably more familiar with spot markets and trading than you think. Some of the most popular markets, like NASDAQ or NYSE (New York Stock Exchange), are spot markets.
What is a spot market?
A spot market is a financial market open to the public, where assets are traded immediately. A buyer purchases an asset with fiat currency or another medium of exchange from a seller. Delivery of the asset is usually immediate, but this depends on what is being traded.
Spot markets are also known as spot markets or cash markets because traders make payments in advance. There are different forms of spot markets, and third parties known as exchanges or brokers often facilitate trades. You can also trade directly with others in over-the-counter (OTC) trades. We'll talk about that soon.
What is spot trading?
Spot traders try to make profits in the market by purchasing assets in the expectation that they will appreciate in value. Later, when the price rises, they can sell their assets on the spot market and consolidate the profits made. Spot traders can also short positions in the market. This process involves selling financial assets and repurchasing more assets when the price falls.
The current market price of an asset is known as the spot price. Through a market order or exchange, you can buy/sell your holdings immediately at the best available spot price. However, there is no guarantee that the market price will remain constant while your order is executed. It is also possible that there may not be enough volume to execute your order at the desired price. For example, if you create an order to buy 10 ETH at the spot price, but only 3 ETH are available at this price, to execute the rest of your order you will need to buy ETH at a different price.
Spot prices are updated in real time and vary as orders match in the order book. Over-the-counter spot trading (also known as OTC or over-the-counter) works differently. You can secure fixed quantity and price directly from the counterparty without an order book.
Depending on the asset, delivery is immediate or normally takes place within T+2 days. T+2 is the trade date plus two business days. Traditionally, stocks and shares required the transfer of physical certificates. The foreign exchange market also transferred currencies through physical cash, electronic transfer or deposit. Now, with digitized systems, transfers occur almost immediately. On the other hand, cryptocurrency markets operate 24/7 and often offer instant trades. Peer-to-Peer or OTC Trading may take longer to complete.
Exchanges vs. over-the-counter
Spot trading is not limited to one place. While most people spot trade on exchanges, you can also trade directly with others without the need for a third party. As mentioned, these sales and purchases are known as over-the-counter trades. Each spot market has its own characteristics.
Centralized exchanges
There are two types of brokers (exchanges): centralized and decentralized. The centralized brokerage manages the trading of assets such as cryptocurrencies, forex and commodities. It acts as an intermediary between market participants and as a custodian of traded assets. To use the features of a centralized exchange, you need to add the fiat currency or cryptocurrency you want to trade with to your account.
An honest and competent centralized broker must ensure that transactions go smoothly. Other responsibilities include regulatory compliance, KYC (Know Your Customer) verification, fair pricing, security and customer protection. In return, the broker charges fees on transactions, listings and other trading activities. Therefore, brokers make profits in both bullish and bearish markets, as long as they have sufficient users and trading volume.
Decentralized exchanges
A decentralized exchange (DEX) is another type of exchange, more common in the cryptocurrency sector. A DEX offers many of the same basic services as a centralized exchange. However, DEXs match buy and sell orders using blockchain technology. In most cases, DEX users do not need to create an account and can trade directly with each other without the need to transfer assets to the DEX platform.
Trades take place directly from traders' wallets, through smart contracts. These contracts are self-executing code on a blockchain. Many users prefer the experience of a DEX as the platform offers more privacy and freedom than a standard centralized exchange. However, there are some negative points. For example, the lack of KYC verification process and customer support can be a problem if you need help.
Some DEXs use an order book model, such as Binance DEX. A more recent development is the Automated Market Maker (AMM) model like Pancake Swap and Uniswap. AMMs also use smart contracts but implement a different mechanism for price determination. Buyers use funds in a liquidity pool to swap their tokens. The liquidity providers that provide the pool's funds charge transaction fees to everyone who uses it.
Over-the-counter
On the other hand, we have over-the-counter trading, also known as off-exchange trading. Financial assets and securities are traded directly between brokers, traders and traders. Spot trading in the OTC market uses several communication methods to organize trades, including telephones and instant messaging.
OTC trades have some benefits of not needing an order book. If you are trading an asset with low liquidity, such as small cap coins, a very large order may cause slippage. Often, the broker is not able to fully execute your order at the desired price, so you have to accept variations in price to complete it. For this reason, large-value OTC trades often offer better prices.
Note that even liquid assets like BTC can suffer from slippage when orders are too large. Therefore, large BTC orders can also benefit from OTC trades.
What is the difference between spot markets and futures markets?
We have already mentioned that spot markets make instant trades, with almost immediate execution. The futures market has contracts paid at a future date. A buyer and seller agree to trade a certain quantity of goods for a specific price in the future. When the contract expires on the settlement date, the buyer and seller typically settle in cash rather than delivering the asset.
To learn more about futures contracts, see the article What Are Forwards 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 we mentioned earlier, spot trading requires you to buy the asset and receive it immediately. On the other hand, margin trading allows you to request interest-bearing loans from third parties and enter into larger positions. Therefore, the loan offers the margin trader opportunities to make more significant profits. However, it also amplifies potential losses. So be careful not to lose your entire initial investment.
How to spot trade on Binance
After creating your account, it is very simple to trade on the Binance spot market. Let's see how to do spot trading using the Binance trading interface. You can find the Spot trading platform by hovering over [Trade] and clicking [Spot] on the Binance homepage.
You will now see the trading interface, which contains different sections.
1. At the top, you can see the cryptocurrency trading pair and other market information such as daily price and volume change.
2. The order book contains all open orders to buy and sell an asset, organized by price. Green orders are buy orders and red orders are sell orders. When you create a market order to buy an asset, you accept the lowest price available. If the order still needs more volume to complete, it will use the next order with the lowest sell price.
3. Here you see the chart containing customizable price history data. TradingView is built into this interface, offering a wide range of technical analysis tools.
4. In the top right corner, you can search for different trading pairs. Here, you can choose the cryptocurrency pair you want to trade on the spot market and register your favorite pairs by clicking on the little stars. Note that you do not need to buy cryptocurrencies with fiat currencies. If you have other cryptocurrencies, you can also exchange them for other coins and tokens on the spot market.
5. In this section, you create your buy or sell orders. As illustrated in the image below, we are in the [Spot] section. Here you can choose between [Limit], [Market] and [Stop-limit] orders.
First we will look at the most basic type of spot trade: the market order. In this example, we want to buy $1,000 (BUSD) worth of bitcoin (BTC). To do this, we just need to enter 1,000 in the [Total] field and click [Buy BTC]. The broker will immediately send the amount in BUSD to the seller and you will receive the equivalent of $1,000 (BUSD) in BTC.
Advantages and disadvantages of spot markets
Each type of trading and strategy has its advantages and disadvantages. It is important to understand this to reduce risks and trade with more confidence. Spot trading is one of the simplest, but it still has positive and negative points.
Advantages of spot markets
1. Prices are transparent and depend only on market supply and demand. This aspect contrasts with the futures market, which generally has multiple reference prices. For example, the reference price on the Binance futures market is derived from other information, including the funding rate, price index, and Moving Average (MA) Base. In some traditional markets, the reference price may also be affected by interest rates.
2. Trading on the spot market is an easy task, thanks to its simplified rules, rewards and risks. By investing $500 in BNB on the spot market, you can easily calculate your risk based on your input and the current price.
3. You can set your position and “forget it”. Unlike derivatives and margin trading, in spot trading, you don't need to worry about a possible liquidation or margin call. You can enter or exit a trade position whenever you want. Furthermore, it is not necessary to check your investments frequently unless you want to make short-term trades.
Disadvantages of spot markets
1. Depending on the asset traded, in spot markets, you may end up holding (storing) inconvenient assets. Commodities are perhaps the best example. If you buy crude oil in cash, you will have to take physical delivery of the asset. In the cryptocurrency industry, storing tokens and coins gives you the responsibility of keeping them safe and secure. When trading futures derivatives, you can still gain exposure to these assets but settle with cash.
2. Stability is very valuable for certain assets, individuals and companies. For example, a company that wants to operate abroad needs access to foreign currency in the foreign exchange market (forex). If the company depends on the spot market, expense planning and revenue would be very unstable.
3. Potential earnings from spot trading are much smaller than futures or margin trading. You can leverage the same amount of capital used in spot trading to trade larger positions.
Final considerations
Trading spot markets is one of the most common ways of trading, especially for beginners. Although this is a simple topic, it is always good to learn more about its advantages, disadvantages and possible strategies. In addition to the basics, it is important to combine your knowledge with a solid foundation in technical, fundamental and market sentiment analysis.
