Arbitrage Trading

Arbitrage trading is a technique used to take advantage of fluctuations of a financial asset in one environment, before they materialize in another.

A trader who pursues this form of trading is known as an arbitrageur. Arbitrage trading can take various forms, dependent upon the market being traded.

Of note, some of these forms can look down upon as unethical or are illegal. Arbitrage trading does not involve technical or fundamental analysis.

Rather, it requires no trading skill whatsoever, apart from the ability to take quick action when price discrepancies occur.

Essentially, arbitrage trading is a form of exploiting the limitations of the financial industry’s technology.

For example, if a trader in shares is seeking out an arbitrage trading opportunity, they may come across a difference in price between two different exchanges.

Arbitrage Trading Explained

So, on one exchange, e.g. the LSE, a company’s share value might be $10.00, whereas on a different exchange, e.g. the NYSE, the same company’s share value could be $10.10.

The trader could then purchase the stock on one exchange and sell it on the other, profiting $0.10 per share.

Another example is in the foreign exchange market, where some traders use automated robots to take advantage of varying exchange rates between different forex brokers.

This results in high frequency scalping, which theoretically is risk free since there is no analysis required.

This requires observing the price of a currency pair on a broker with a fast price feed, and taking advantage of this by trading the same currency pair on a broker with a slow price feed.

However, a lot of forex brokers frown upon this type of trading, and any profits attained via such methods are typically wiped out by the broker.

Ideally, the rates on both brokers should always be the same, but the flaws of some brokers or exchanges creates this arbitrage opportunity.

This simply would not exist if everything was consistently efficient across the board.

However, even when there is a price difference between the same asset on different brokers or exchanges, it still doesn’t necessitate an arbitrage opportunity.

Ultimately, there are of course costs involved with any transaction, such as the commission or spread.

In addition, slippage can also occur which often renders arbitrage trades unsuccessful.