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Conceptions in Spot trading (Understanding Spot Trading)

Updated: May 17, 2022

What is Spot trading?

Spot traders try to make profits in the market by purchasing assets and hoping they’ll rise in value. They can sell their assets later on the spot market for a profit when the price increases. The current market price of an asset is known as the spot price. Using a market order on an exchange, you can purchase or sell your holdings immediately at the best available spot price.

However, there’s no guarantee that the market price won't change while your order executes. There also might not be enough volume to satisfy your order at the price you wanted. For example, if your order is for 10 ETH at the spot price, but only 3 are on offer, you will have to fill the rest of your order with ETH at a different price. Spot prices update in real-time and change as orders match. Over-the-counter spot trading works differently. You can secure a fixed amount and price directly from another party without an order book.

Depending on the asset, delivery is immediate or typically within T+2 days. T+2 is the trade date plus two business days. Traditionally, shares and equities required the transfer of physical certificates. The foreign exchange market also previously transferred currencies via physical cash, wire, or deposit.

Now with digitized systems, delivery takes place almost immediately. Crypto markets, however, operate 24/7 allowing for usually instant trades. Peer-to-Peer trading or OTC can however take longer for delivery.

What is Liquidity?

Liquidity is the measure of how easily you can convert an asset into cash or another asset. You may have the rarest, most valuable old book in your backpack, but if you're alone on a remote island, it will be difficult to find a buyer. On the other hand, if you'd like to buy $100 USD of BTC on the BTC/USDT pair on MoonXBT, you'll be able to do it almost instantly without any impact on price. This is why liquidity is important when it comes to financial assets.

What is market liquidity?

Market liquidity is the extent to which a market allows for assets to be bought and sold at fair prices. These are the prices that are the closest to the intrinsic value of the assets. In this case, intrinsic value means that the lowest price a seller is willing to sell at (ask) is close to the highest price a buyer is willing to buy at (bid). The difference between these two values is called the bid-ask spread.

What is bid-ask spread?

The bid-ask spread is the difference between the highest bid price and the lowest ask price of an order book. In traditional markets, the spread is often created by the market makers or broker liquidity providers. In crypto markets, the spread is a result of the difference between limit orders from buyers and sellers.

If you want to make an instant market price purchase, you need to accept the lowest ask price from a seller. If you'd like to make an instant sale, you'll take the highest bid price from a buyer. More liquid assets (like forex) have a narrower bid-ask spread, meaning buyers and sellers can execute their orders without causing significant changes in an asset's price. This is due to a large volume of orders in the order book. A wider bid-ask spread will have more substantial price fluctuations when closing large volume orders.

Market makers and bid-ask spread

The concept of liquidity is essential to financial markets. If you try to trade on low-liquidity markets, you might find yourself waiting for hours or even days until another trader matches your order.

Creating liquidity is important, but not all markets have enough liquidity from individual traders alone. In traditional markets, for example, brokers and market makers provide liquidity in return for arbitrage profits.

A market maker can take advantage of a bid-ask spread simply by buying and selling an asset simultaneously. By selling at the higher ask price and buying at the lower bid price over and over, market makers can take the spread as arbitrage profit. Even a small spread can provide significant profits if traded in a large quantity all day. Assets in high demand have smaller spreads as market makers compete and narrow the spread.

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