Introduction to Financial Instruments – Part 1 – The Spot Market

Financial instruments are assets that can be traded or exchanged by parties within a financial market. These instruments are used for investment purposes and portfolio diversification. Financial instruments include stocks, bonds, derivatives, mutual funds, and foreign exchange (Forex). These instruments allow investors and traders to benefit from market fluctuations, manage risk, and achieve their financial goals.

Spot Market

One of the most popular financial instruments is Forex trading, specifically in the spot market. The spot market allows for the quick purchase and sale of currencies at the current exchange rate or spot rate. The spot market is characterised by high liquidity and high volatility, making it a popular instrument for traders looking to profit from short-term price movements.

A spot deal in the Forex market is a bilateral contract between two parties where one delivers a specified amount of a given currency against receipt of a specified amount of another currency from the counterparty, based on an agreed exchange rate, within two business days of the deal date. The two-day spot delivery for currencies was developed long before technological breakthroughs in information processing, making it necessary to check all transaction details among counterparties. The major currency pairs traded in the spot market are the U.S. dollar, euro, Japanese yen, British pound, and Swiss franc.

Spread, Quota, and Pips

In the spot market, banks serving traders provide quotes indicating the evaluation of the currency traded against the U.S. dollar or another currency. A quota consists of two figures, with the left part called the bid-price (the price at which the trader sells) and the right part called the ask-price (the price at which the trader buys the currency). The difference between the ask and bid price is called the spread, which is measured in points or pips. The spot market offers a short contract execution time, resulting in a restriction on credit risk. Both realised and unrealised profit and loss can occur in the spot market.

Characteristics of the Spot Market

The spot market is characterised by high liquidity and high volatility, making it popular among traders looking to profit from short-term price movements. The volatility of the spot market refers to the degree to which the price of a currency tends to fluctuate over a period of time. In an active global trading day, the euro/dollar exchange rate may change up to 18,000 times, flying 100-200 pips in a matter of seconds if the market receives significant financial, economic, or political news. The exchange rate may remain quite static for extended periods of time, waiting for the next market to take over, or during crucial technical trading gaps.

Overnight Trading and Spot Market Popularity

Overnight trading in the spot market is limited due to few banks having overnight desks. Most banks send their overnight orders to branches or other banks that operate in the active time zones. The popularity of the spot market is due to fast liquidity taking place thanks to volatility and the short time of contract execution, restricting credit risk. The profit and loss can be either realised or unrealised, changing continuously in tandem with the exchange rate. Trading the spot market requires not just technical skills but also risk management abilities, strategy planning, and insight into market analysis.

Disclaimer:

This information is not considered investment advice or an investment recommendation, but instead a marketing communication. iFX is not responsible for any data or information provided by third parties referenced or hyperlinked, in this communication.

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