In trading, arbitrage has become widespread due to the ability to almost completely eliminate the risk when conducting this type of operation.
As a rule, arbitrage trading involves the simultaneous conclusion of oppositely directed transactions in financial instruments that have a high correlation with each other. Or it can be simultaneously concluded deals with the same financial instrument, but on different trading floors.
Forex arbitrage attracts traders’ attention because it allows you to make profit with minimal risk. Arbitrage trading becomes possible because the prices for the same trading instruments differ from one broker to another. The reasons for the discrepancy in quotes may be different – for example, software problems, or the use of various liquidity providers.
You probably noticed these differences in quotes if you already have experienced trading with several brokerage companies. Here they can be used to make a profit. The classic version is the buying of an asset on one exchange and its selloff on another.
Forex arbitrage allows you to earn using different strategies. But in this article, we will talk about two of them.
Classic arbitrage deals
To apply this strategy, you must have trading accounts in two brokerage companies. At the same time, quotes for trading instruments should differ significantly. A trader opens a buy order with a broker whose asset price is lower and almost simultaneously, he opens a sell order for the same asset with the second broker, whose price is higher. Now the trader has to wait for the price of both brokers to be the same. This is the closing time of both orders. In arbitration, transactions should take into account the value of the spread and commission (if any) that can kill the profit. The volume of transactions with brokers should be the same.
This is a more complex strategy because, in it, the trader deals with three currencies. They must be interconnected. For example, you can open deals on three currency pairs: EUR/USD, EUR/GBP, and USD/GBP.
Schematically, triangular arbitration may look like this. The trader chose three currencies: B1, B2, and B3. He buys B2 for B1, B3 for B2, and B1 for B3. Or in the form of a formula: B2-B1 + B3-B2 + B1-B3 = 0. This arbitrage strategy does not require opening accounts with different brokers. Transactions can be made on one trading account.
Disadvantages of Forex arbitrage trading
Like any other trading method, arbitrage trading, along with advantages, has its drawbacks. we will indicate the main ones.
Some brokers prohibit such transactions or take measures that complicate them, or even make them pointless. The more decimal places in quotes, the smaller the gap between them and if we take into account spreads and commissions, then the profit is nullified.
Opening arbitration deals requires not only increased attention but also swift action and not every trader can handle this.
Forex arbitrage does not make sense to test in demo trading. Almost all brokers have demo account quotes different from real account quotes. Therefore, even if a significant price difference is recorded on demo accounts, this does not mean at all that it is also on a real account.