Spot trade is the simplest type of exchange operations which appeared when first Exchange Houses were formed in XIV-XV century. Foreign exchange spot trading is buying of one currency with another currency for immediate delivery. It’s used not only for actual purchases but for exchange risk safeguarding and profiteering. Spot exchange rate shows how does national currency is currently valued abroad.
Notwithstanding that spot trading means immediate delivery, usually settlement is done within two working days from the date of trade execution. This time is needed for the paperwork involved and bank money transfers. Otherwise it’s practically impossible to effect synchronous fulfillment of the parties’ obligations under the deal, especially when they located in distant time zones.
An exact date of the settlement of a spot trade is called “value date” and it defines a moment when monetary funds become available to a contractor. If a second day from a deal’s date comes for weekend or public holiday the value date is shifted to the next working day. Sometimes a value date is set for the same (TOD – abbreviation from “today”) or next (TOM – for “tomorrow”) day as a trade execution. Rates for these deals are influenced by overnight interest rates for relevant currencies.
On Foreign Exchange Market prices are represented as bilateral exchange rate quotation where the relative value of one currency unit is denominated in the units of another currency. The first currency is called the base currency, the second currency – counter currency (or quote or price currency). In most cases USD is used as a base currency.
Quotes using a country’s home currency as the price currency and foreign currencies as the base are known as direct quotation and are used by most countries (for example USDRUB 28,9028 means 28,9028 Russian Rubles for one US Dollar). Quotes using a country’s home currency as the base currency are called indirect quotation. Historically indirect quotes were used for Great Britain Pounds – GBPUSD 1,6127 meaning 1 pound = 1,6127 dollars. Direct quotation is inverse to indirect, i.e. Direct quote = 1/Indirect quote.
Price quotations that do not involve the US dollar or do not involve national currency of quoting country are called cross rates. Usually cross rates are calculated as derivatives of USD direct quotes.
An exchange rate, applied to a customer willing to purchase a quote currency (equals to selling of a base currency) is called BID. And a price of quote currency selling (equals to base currency purchase) is called ASK. BID is always lower than ASK. The difference between ASK and BID is called spread. It covers brokerage service costs and replaces transactions fees. Sometimes a relative difference in sell/purchase prices is also calculated – it’s then expressed in basis or percentage points.
Wide range of offered quotations makes trading very convenient as it eliminates necessity of additional calculations. It is market convention to quote most currency pairs up to 4 decimal places for spot transactions. The fourth decimal place is usually referred to as a percentage in point or pip. One hundred pips make so called “big figure”, which usually do not change during a trading day. Normal intraday fluctuation of an exchange rate does not exceed last two decimal places of quotation.
Foreign exchange quotations are set by market makers, i. e. trading firms or banks offering both a buy and a sell price. Their customers are called market takers because they accept offered conditions, executing forex spot trading deals under quoted prices. Traders open positions in different currencies and their total executed deals result in net position which determines profit of a trader.