Foreign exchange spot
Foreign exchange spot contracts are the most common and are usually for delivery in two business days, while most other financial instruments settle the next business day. Futures contracts are usually inclusive of any interest amounts.
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Spot trading most commonly refers to the spot forex market, on which currencies are traded electronically around the world. Most spot currency trades settle two business days after the execution of the trade, with the exception of the U. Holidays can cause the settlement date to be far more than two calendar days after execution, especially during the Christmas and Easter seasons.
The settlement date must be a valid business day in both currencies. The most commonly traded currency pair is the euro vs. Currency pairs that do not include the U.
Spot trades are usually executed between two financial institutions or between a company and a financial institution. Spot trades can be undertaken for speculative purposes or to pay for goods and services. Spot trading has become more widespread in the past 10 years because of the ease in trading with electronic systems and internet-based trading systems.
Most interest rate products, such as bonds and options, trade for spot settlement on the next business day.
Contracts are most commonly between two financial institutions, but they can also be between a company and a financial institution. An interest rate swap in which the near leg is for the spot date usually settles in two business days.
Commodities are usually traded on an exchange. Most commodity trading is for future settlement and is not delivered; the contract is sold back to the exchange prior to maturity, and the gain or loss is settled in cash. The price for any instrument that settles later than spot is a combination of the spot price and the interest cost until the settlement date. In the case of forex, the interest rate differential between the two currencies is used for this calculation.
In the spot market, there is no central exchange, and therefore no uniform price. However, arbitrageurs and the competitive nature of the market ensures that the currency prices are more or less the same at any given time. The biggest difference between spot FX and currency futures is the settlement date. Generally, spot trades are settled within 2 days of the transaction. This is called the spot date, and this is the date when the delivery of the currency is made. The first obvious advantage of spot trading is that you can find a counter party to your trade at any time throughout the day, every day from Monday to Friday.
There are no exchange hours, and therefore no overnight risk although there IS that risk if you carry your position through the weekend. Another major advantage of trading spot FX is the massive liquidity available to you compared to the futures market. The spot market is the first place that every major institution and trader will go to do their trades, which means that you can expect better spreads and the ability to take larger positions without worrying about slippage.
Instead of paying the commission to the exchange for each round turn lot, you pay a slightly increased spread to your broker. Finally, and most importantly to the retail trader, you can buy smaller lots than the standard , unit lot in the spot market. If you were trading futures, your minimum trading size would be 1 lot of the standard contract size.