To get the trick of forex arbitrage, I am going to throw a little light on the meaning of the word arbitrage itself.
Arbitrage is the process of simultaneously buying and selling an asset to profit from differences in the pricing of the asset in different markets.
Arbitrage opportunities present themselves in everyday markets.
Whether it is in the capital market, the foreign exchange market, or your everyday grocery store setting.
The benchmark is two major things.
Supply and demand and sometimes a lack of information. Supply and demand are the foundation of arbitrage.
The simultaneous push and pull of supply and demand in the market allow for lapses to exist.
Demand concentrates in a particular place creating a need for supply.
This in turn reduces the price of the goods or assets in the same place saturated with demand.
And creates a lack of demand in another market selling a similar product.
An Example Of Abritrage Trading in Real Life
Imagine two markets.
The first market ( Market A), sells grapes for $1 per kg.
The second market (Market B), sells grapes for $1.50 per kg.
Keep in mind that customers buying from Market B are not aware that the same quantity is at the cheaper price from market A.
The difference in prices is because of the lack of information.
As a smart businessman, you decided to take advantage of this.
So, every morning, you go to market A to buy at a much cheaper price and go to market B to sell at a higher price.
For every kilogram you sell, you are a risk-free profit of 50 Cent because of the discrepancies in both Markets.
The same applies to the foreign exchange markets.
In the forex market, the buying and selling of currencies on different exchanges give room for arbitrage trading.
A currency could be trading for $1.59 in an Exchange and still be selling for $1.69 On another exchange.
Such arbitrage opportunities arise because of the push and pull or supply and demand.
The inconsistency between the price of an asset on one exchange usually occurs because of the different volumes of buying and selling of the assets in question on different exchanges.
However, due to the advent of modern technology, exploiting these inconsistencies has become extremely difficult, especially in the forex market.
Advancements in technology have led to the creation of automated trading systems programmed to monitor closely differences in prices in prices of similar financial instruments.
Although these opportunities still exist. It just has become highly competitive majorly because of how short the lapses last.
Not to mention, the number of traders who are also looking for these arbitrage opportunities.
Forex Arbitrage Explained
There are several strategies traders use to earn money while trading.
Forex arbitrage is almost neither of them.
The practice of arbitrage is regarded as a riskless strategy.
This is because it just capitalizes on lapses in markets and the pull of supply and demand.
Nevertheless, other kinds of risk may arise.
These risks may involve risks associated with the implementation and execution of arbitrage strategies.
The only way to go around these risks would be to spend a good amount of money on cutting-edge, high-frequency automated trading systems or bots that would be able to match the programs created to correct price distortions in the first place.
Triangle Arbitrage – How Forex Arbitrage really works
The approach that better demystifies forex arbitrage is the triangular forex arbitrage strategy.
Triangular arbitrage involves the use of three or more currencies.
It involves the simultaneous buying and selling of currencies to take advantage of the difference in prices of the three different currencies.
Here is triangular arbitrage in 3 different stages:
An individual trader opens a long EUR/USD position, by buying €10,000 And selling 11,000
The trader then opens in short position EUR/GBP, purchasing £8000 in exchange for the sale of 10,000
After that, the individual opens a short position GBP/USD by buying 11,044 and selling 8,800
The trader closes all three positions with a $44 profit.
Key takeaways? what is Forex arbitrage
- Forex arbitrage is the simultaneous buying and selling of currencies from different markets.
2. Forex arbitrage capitalizes on the price discrepancies created by supply and demand in different markets.
These arbitrage opportunities do not present themselves in the market very frequently.
Inconsistencies in the price of currencies or assets in different markets are being met by high-end technology programs installed for the specific purpose of correcting pricing inconsistencies.
This in turn limits the discrepancies sometimes fractions of a second.
Although traders have created high-frequency trading algorithms and bots that can speedily trade these pricing distortions.
While these high-frequency trading systems are sophisticated and expensive, they are your best shot at forex arbitrage.
Have you used any arbitrage bot in the past? Share your experience with the comment box below.