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.
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.