What it means
A spot trade is the simplest kind of transaction in a market: you agree a price today, and the exchange of money for the asset takes place almost immediately. The price you pay is the market price at that moment, not a price agreed for some future date.
Currencies, shares, bonds and commodities such as gold and oil can all be traded on a spot basis. The settlement timetable varies with the market, and for most major currency pairs it is two business days after the deal, known as the spot date.
Because the price is set at the moment of the deal, the buyer takes on whatever the market does next. If the price jumps an hour later, the buyer gains, and if it falls, the buyer loses, and there is no protection built into the trade.
This is why businesses with predictable foreign payments often prefer to fix the rate in advance. Businesses use spot trades for needs that are immediate or uncertain in timing, such as paying an invoice in a foreign currency, topping up a stock of raw materials or investing surplus cash.
The ease of dealing is its main attraction, and the lack of a long-term commitment is another. The cost of a spot trade includes the spread, which is the gap between the buying and selling prices, plus any commission or fees.
For large or illiquid trades, the act of trading itself can push the price against the trader. Spot trades are the foundation for other deals.
Forward and futures prices are calculated from the spot price, and hedging strategies usually start by identifying the spot exposure that needs protection.
In practice
Real-world examples.
Example
A company in the United States must pay a supplier 150,000 euros. The treasurer buys the euros from her bank on a spot basis at that day's rate, and the euros are delivered two business days later. She compares the bank's quote with a second quote before dealing, because a small difference on a large amount is real money.
Example
A coffee roaster runs short of beans after a large unexpected order. The purchasing manager buys an extra 10 tonnes on the spot market at the going price, so that the roasting schedule is not disrupted. He accepts a price slightly above his contract price in return for getting the beans immediately.
Example
A private investor places an order to buy 200 shares of a listed company at the current market price. The order is filled in seconds, and ownership transfers when the trade settles. He can sell them again at any time that the market is open.
Formula
Calculation
Trade value = quantity x spot price
A jewellery manufacturer buys 50 ounces of gold on a spot basis at $2,000 per ounce. Trade value = 50 x 2,000 = $100,000. If the dealer charges a fee of 0.25%, the fee is 100,000 x 0.0025 = $250, so the total cost is 100,000 + 250 = $100,250.Case study
Seen in the real world.
Sunvale Foods is an illustrative, fictional exporter that buys packaging from a supplier in another country and pays in that supplier's currency. Its finance manager used to make a spot trade on the day each invoice was due.
Over six months, the currency moved against Sunvale by around 3% on three occasions. On a typical $200,000 invoice, each move added $6,000 to the cost, so the total unplanned cost across the half year came to about $18,000.
The illustrative lesson is that a spot trade is simple but gives no price certainty. Sunvale kept spot trades for small payments and began using forward contracts for the larger, predictable ones. The finance manager now reports the difference between the budgeted and actual exchange rate each month, so the board can see the benefit.
Watch out
Common mistakes.
- Believing a spot trade settles instantly, when delivery usually takes one or two business days.
- Leaving large, predictable currency payments to a spot trade on the due date, which exposes the business to price changes.
- Overlooking the spread and fees, which can be a significant part of the cost on small trades.
Questions
People also ask.
How is a spot trade different from a forward trade?
A spot trade is settled within days at today's price, whereas a forward trade fixes a price now for settlement on a later agreed date.
Can I cancel a spot trade?
Generally not, since the price is agreed at the time of dealing and you would have to enter an opposite trade to reverse your position, possibly at a different price.
Who takes the risk of price changes after the deal?
The buyer and seller each bear the risk of price movements on their own positions after the trade, so a buyer loses if the price falls and a seller loses if it rises.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related