The forex market encompasses many different financial instruments and trading arenas, each having its set of rules, peculiarities, and practices. With an extensive sphere, two main kinds of Forex are the spot market and the futures market. Both of them are famous subcategories of the Forex activities. Traders often ask whether the spot market is better to make trades or futures markets. If you’re looking to make a long-term investment, the spot market is better. But for those who want to use increased leverage or wish to hedge their trades, trading in the futures market is a better option.
Explain Futures Market and Spot Market in Brief
The spot market is also known as the cash market. It’s where the exchange of different financial instruments takes place immediately. Currencies and stocks are the most famous spot market instruments. For those who trade currencies, the Fx market is a big global spot market. The thumb rule for spot markets is that the asset ownership will transfer instantly following a sell or buy transaction.
In the futures market, participants can sell and buy contracts for delivery in the future on a specific date. The futures market includes different instruments like stock indexes, currencies, commodities, and more. In the future market, financial instruments are also called derivatives. It is because contract pricing depends on the basic security in cash markets.
Spot Market Vs. Futures Market: Comparison
As futures traders get settled in the future, there is associated counterparty risk, and to mitigate the risk there are two types of techniques used – performance bonds and maintenance margin. As in the spot market, the margin is an upfront fee, and there is no counterparty risk.
Another difference is that for spot markets, the settlement time period is two working days, while in futures markets, the settlement date is set in the future.
Traders mainly use the futures market to hedge against the spot market as the leverage is greater in the futures market. The margin and leverage both work differently in the spot and futures market. In the future, the margin requirement is lesser than the equities, and for most of the exchanges, it is 25%.
Examples of Spot and Futures Market
The spot market is different from the futures markets. if spot market, delivery takes place almost immediately. For example, if someone wishes to purchase XYZ’s shares and own them, he would need to go to the cash market where shares are traded.
A futures contract is an agreement made to buy or sell the commodity on a particular date for a determined price. For example, in a Futures contract, someone will make the contract to buy XYZ company’s share on a specific future date at the market price.
Does the Future Affect Spot Prices?
The spot price is a quote for the immediate purchase of a particular commodity or a share. The futures price is a trade that will happen at a later date. The future price of a commodity depends on its current spot price with the carry cost during the interim before delivery. Carry cost involves the price of storage of the commodity that also includes insurance and interest along with other expenses.
Speculation on the futures market includes two traders in which one party believes that the price of the commodity will rise and the other believes that the price will fall. They put their money based on this speculation only.
To conclude, spot markets are mostly affected by supply and demand, while futures markets are influenced by the expectations of the future prices based on the factors like storage costs, weather predictions, and other related factors. Apart from this, if you want to earn a huge profit, you need to opt for regulated forex brokers, as they have various facilities that makes users work more efficient.