Financial Literacy

How Does the Spot Market Work?

The spot market isn’t any one single market. Instead, it refers to a selection of cash markets where asset exchange happens in real time. These markets are fast-paced, with buying and selling happening congruently. They’re active, liquid markets, with every buy, sell and trade determining the price of assets. 

The most well-known spot market is the stock market. You can jump on any time during trading hours and exchange money for securities—or securities for money. The transaction happens immediately, in seconds. This is also why spot markets are commonly referred to as cash markets. They function the same way as a retail environment: money exchanged for goods. This is also why the spot market is the first exposure to investing and trading many people have. 

Traders investing in the spot market

What is a Spot Price?

The spot price is the current price of an asset if you chose to purchase it at that given time. In spot markets, this changes by the minute. A company’s stock might open the day at $12.50, reach $12.85 by lunch time, plummet to $12.20 by midday and close at $12.60. Whenever you choose to buy, you’ll pay the current price. 

More than a number, the spot price is the price a seller is willing to sell at and a buyer is willing to pay for it. It’s a representation of free market supply and demand, and valuation. If no one’s buying, the price drops. If investors hold, the price goes up. This is also why there are bearish and bullish tendencies within spot markets. 

Types of Spot-Traded Products

There’s an assortment of financial products traded on the spot market. Because this market involves immediate exchange of cash for securities, it deals only with real assets (no derivatives). Here’s what you can expect to find on the spot market:

  • Securities: Both debt and equity securities are spot-traded products. Bonds have a fixed rate price that doesn’t change, while stocks change by the minute. Nevertheless, the exchange between investors and issuers occurs immediately, which means the selling price is the spot price. 
  • Commodities: Commodities like precious metals, crops and natural resources fluctuate in price, but sell and trade at current prices. While commodities are popular on derivative markets, the underlying assets themselves are a big part of the spot market.
  • Currencies: Currency pairs trade at exchange rates that constantly change. Buying and selling at different rates is how the forex market functions, making it the largest representation of a spot market. Spot quotes are what determine if a trade is profitable or not relative to the quote currency.

The key similarity between these products is a known price. When you make the decision to trade securities, commodities or currencies, you know exactly how much they’re worth. Whether you’re buying or selling, the price you see is what you’re working with. 

How to Buy, Sell And Trade on the Spot Market

Buying and selling in the spot market happens two ways: through exchanges or over-the-counter. In the stock market, for example, you can buy stocks on an exchange through your broker. While there might be a fee to process the trade, the list price of the stock at the time you buy represents the price paid to own it. In an OTC market, buyers and/or sellers determine the price before the exchange. 

It’s important to realize that while sales happen in real-time, settlements don’t. Settlements happen in T+X days, such as T+2 for stock market transactions. This is the time it takes for funds to officially change hands. Short of hosting an in-person exchange—such as paying cash for a container of goods—funds take time to move between accounts. While you’ll own the security you buy immediately, you may not have access to its cash value for T+X days. 

Key Spot Market Terms to Know

Spot markets are relatively familiar and straightforward, which makes them easy to understand. That said, there are still a handful of terms that new investors may need to get familiar with before they start trading. Here’s a few of the most common:

  • Exchange: This is where you find, buy and sell securities. Exchanges provide liquidity.
  • Spot price: The price for a security at that very moment. Subject to change.
  • Cash market: Another name for spot markets, where exchanges happen instantly.
  • Settlement: The availability of proceeds from an exchange after the transaction.
  • OTC: Over-the-counter transactions, which happen direct between buyer and seller.
  • Bullish: Rising spot prices, driven by heightened demand for a security.
  • Bearish: Falling spot prices, driven down by reduced demand or reluctant sellers.

The further you delve into individual types of spot markets, the more specific the terminology becomes. What’s important is understanding the type of asset you’re buying or selling, and what determines that asset’s value. For stocks, it might be a company’s performance. For bonds, it might be the combination of interest rate and term. For commodities, it’s a slew of variables. The more you know about the variables that govern spot value, the more aware you are as an investor. 

The Basic Functions of The Spot Market

Because it’s a highly active, transparent environment, the spot market’s primary function is to set prices fairly. High liquidity means there’s enough buying and selling activity to establish “free market” prices. There’s also information available to inform those prices. For example, you can look up a company’s 10-K filing to see its balance sheet, to accurately evaluate its stock price.  

Cash markets are accessible, liquid and transparent, which makes them universally good investment mediums. From institutional investors to retail traders, the spot market is synonymous with the free market because participants determine the prices.

Did you know there a various financial markets for investors to consider? To learn more about these markets, sign up for the Investment U e-letter below. You can grow your knowledge of stock trading, retirement savings, the spot market and much more.


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