While it is not uncommon for beginners to confuse spot and futures markets, there is a (somewhat) clear distinction between the two. The main (and obvious) difference is that spot markets employ a “cash & carry” policy, where the commodities (or securities, etc.) are delivered immediately upon payment, or shortly thereafter, whereas futures markets employ a longer delivery period, and/or a delayed transaction. However, there is more to these two than meets the eye, and we are about to see why.
What are the spot markets, and how exactly does it differ from futures markets?
Well, a spot market (sometimes called a physical market) is a type of market where the monetary transaction and delivery are carried out simultaneously, or one closely follows the other. Any contracts made on this type of market are realized immediately. This is the traditional type of market, and the principles are as old as trade itself. However, modern times have changed them somewhat, and this gave way to some gray areas: apparently, even futures can be traded on spot markets, as long as the delivery period is 30 days or less. The exact delivery period may be open to debate, but after stretching it that long, can we even talk about spot and futures markets being separate? Actually, we can, for now. Futures markets, on the other hand, enable you to arrange a transaction but postpone it for another date, hoping that the conditions will be more (or less) favorable than they were at the time the deal was struck. But given how volatile financial markets are, the line often gets blurry. It all depends on how long does it take to assume ownership over newly acquired property, or asset.
What does this mean for Forex traders?
When you’re trading currencies, you get to choose between currency futures or the good, old-fashioned (spot) Forex market. Since the whole point of Forex trading is to acquire a certain amount of currency and wait for its value to increase so you can make a profit, there are some similarities between buying it outright and pre-arranging a trade but not concluding it until a later date. Those who opt for the latter possibility, can either use the currency they own at that point in time, or kind of “hope to be able to afford it” by the time the transaction is concluded – a risky strategy at best, since a currency future is legally binding, and an inept Forex trader can find himself in a world of hurt. However, if the spot price changes significantly in the meantime, the gambit will pay off and the trader will profit immensely.
As with other markets, the difference between spot and futures Forex markets is the moment the exchange happens; if it is immediately after payment, we are talking about a spot market. Otherwise, chances are this is a futures market. Just remember: very few futures contracts are actually concluded as planned.
