What Is Arbitrage

Trading Strategy

neon world map    Simultaneous purchase and sale of identical or similar securities, commodities, or foreign exchange in different markets or in different forms, to profit from unequal prices. The ideal version is riskless arbitrage ( risk-free transaction consisting of buying an asset at one price and simultaneously selling that same asset at a higher price, generating a profit on the difference ) Formally, theoreticians define an arbitrage as a trading strategy that requires the investment of no capital, cannot lose money, and has a positive probability of making money. In practice, there is always some risk i.e. requotes, slippage. However, while price discrepancy lasts, order can be opened after one or some number of requotes. To avoid slippage we recommend using Instant Execution order type.

   Arbitrage opportunities reflect minor pricing discrepancies between markets or related instruments. An arbitrageur is an institution or individual who engages in arbitrage. Most arbitrage is performed by institutions that have low transaction costs and can make up for small profit margins by doing a large volume of transactions. It has been in wide use for several decades, so it is fairly standard. 

   Arbitrage is the holy grail of every trader. The dream of buying low and selling high (for this is what arbitrage is all about) is the driver of all commerce but also its own worst enemy: for as everyone is trying to pursue it, the potential for arbitrage disappears. And when it does disappear totally, we have equilibrium. A market is said to have no arbitrage or be arbitrage free if prices in that market offer no arbitrage opportunities. This is a theoretical condition that is usually assumed by economic and financial models. Much of the theory of asset valuation is based on the assumption that prices must be set in a consistent manner that affords no true arbitrage between them. This is called arbitrage-free pricing. A market in equilibrium must be arbitrage free.

   Now, the beauty of digital markets is that we have all the data at our disposal. We can actually observe how far or how close to equilibrium our financial instruments are. So, folks, it is official: There is plenty of room for arbitrage. Moreover, this arbitrage window varies in size constantly - some nice graphics.

We need to be able to:

- spot the presence of arbitrage opportunities, looking out for fluctuations in quotes

- measure the arbitrage potential in real time

- immediately take proper action 

When arbitrage gives way to equilibrium, we know with considerable certainty big capital entered the game.

web resources

Other valuable resources:

- Check what is arbitrage according to  Wikipedia.

- Check what is arbitrage according to  Investopedia.

- Check what is arbitrage according to  Investopedia ( video version ).

- Check what is arbitrage according to  About: Page 1 ( general description ), Page 2 ( forex related ), Page 3 ( financial markets ).

- Definition of Arbitrage Opportunity according to  Economics Glossary.

- A Beginner's Guide to Exchange Rates and the Foreign Exchange Market Part 2: Exchange Rates - Arbitrage.

Why Arbitrage?

chart - coin bars

1. Less risk
The arbitrage is in theory a risk- free strategy. The risk is virtually zero as the arbitrageur enters into two or more transactions of identical or equivalent instruments in two or more markets at the same time. Although risk is minimized, in practice there is no zero risk.

2. Frequent opportunities
Great selection of available brokers.
A point that has to be noted is that when there is a slight variation in the price of the currencies there would be an immediate speculation among the speculators and traders. Since the fluctuation depends mainly on supply and demand on the financial instruments,  an action should be taken immediately.

3. Flexibility
Many accessible financial instruments, currencies to monitor for price fluctuations. Besides, you can trade as usually but in the mean time: forex arbitrage is not a rare opportunity and if it comes, then you can grab it without any hesitation.

4. Best Rule Ever !!!
( affects United States based accounts ) NFA Compliance Rules regarding: 

  • Price Adjustments,
  • Price Slippage and Price Requoting.

      Learn More

Where To Arbitrage?

Box with money

Forex- No Centralized Market!

    The foreign exchange market is not deemed to be centralized because there is no one location where currencies are traded and it is possible for traders to find competing rates from various dealers from around the world. The spot foreign exchange (forex or FX) market is the world's largest market, with over one trillion U.S. dollars traded per day. According to the Forex Guide, a guide to foreign trading, "Foreign exchange transactions take place without any unification of the operation market and business network." The operation market controls the channels through which trades occur, while the business network provides the capital for the trades. In the foreign exchange network, these two systems are not formally organized. The foreign exchange market never closes down during the work week. It operates twenty-four hours a day, across national boundaries. Forex has great potential for frequent arbitrage opportunities and is the favourite arbitrageur's market.

Test Drive

Two computer monitors presenting trading software

   The first step is to pick a broker with which to trade. Some are faster than others, some just provide different quotes from time to time, some have tighter spreads. Each broker has its own advantages and disadvantages, but take a note: all these should be checked on real accounts. Here (AONet- Arbitrage Opportunity Network ) you can ask arbitrage-related key questions when doing your due diligence.

   Once you've found a broker, we encourage you to test software by opening a demo account. Most demo accounts have exactly the same functionalities as the live accounts, with real-time market prices.(Demo price feed and order execution may be slightly different from real accounts) Main difference, of course, is that you are not trading with real money. Demo trading allows you not only to make sure that you fully understand how to use the trading platforms, but also to practice trading strategies and to make money in virtual account before you move onto a live account funded with real money.