What Is Forex Arbitrage And How Can You Use This Strategy?
Sometimes, many people ask: “What is Forex arbitrage?” And the answers they find on the Internet tend to be pretty vague. For this reason, we have prepared this article to explain what Forex arbitrage really is.
This is a strategy that does not carry any risk for operators. Forex arbitrage is a technique used by thousands of people around the world.
However, it should be mentioned that any arbitrage model brings unique risks, unavoidable challenges and costs that are not associated with common trading systems.
Therefore, it is crucial that you consider the following 4 points:
► You will need much more time.
► Many of these arbitration systems require considerable investments in computers and network hardware.
► Requires extensive experience in trading, mathematics and computer science.
► Arbitration is constantly evolving, so it is a good idea to check the latest developments on the subject often, as information on the Internet may be out of date.
We also want to address potential ethical issues. Some people believe that certain forms of Forex arbitrage take unfair advantage of the market.
Although this is up for debate, the main problem is that your personal perceptions may prevent you from withdrawing your winnings (we will examine this in detail later).
Basic Concepts to Use This Strategy
The first Forex arbitrage strategy, known as currency arbitrage, requires you to quickly search for different opportunities (while they are available) generated by price inefficiencies.
This involves buying and selling multiple currency pairs to take advantage of such inefficiencies. Traders generally practice arbitrage with two currencies, where they take advantage of the differences between the spreads of two currencies (there may be variations, which we will explain later).
Spread is the effective distinction between two instruments that can provide FX arbitrage opportunities, therefore it is a fundamental concept in any Forex arbitration system. To carry out this strategy, it is necessary:
► Access price quotes in real time;
► Act immediately according to opportunities.
There are arbitration calculators that can help you quickly find opportunities. Such calculators are quite common on the Internet, so you should have no trouble finding a good option.
You can also buy Forex arbitration calculators on many third party websites and Forex brokers. In some cases, these calculators are offered for free or as trial software after opening an account.
Types of Arbitration Strategies and Their Applications
It is important to talk about the triangular arbitrage strategy, which is a common practice in the forex market. What is special about this type of arbitration is that its process is gradually organized.
For this reason, even a single “irrelevant” discrepancy can cause the triangular forex arbitrage process to fail. This is because said kind of arbitration can be understood as a susceptible or substantial phenomenon.
The idea is that inefficiencies, which occasionally occur, mean that you will end up choosing more units of currency than before.
These inefficiencies occur daily in the markets, but as we mentioned earlier, they are only available for a short period of time.
You may be wondering, “What are the steps necessary to execute this kind of strategy?”
► Exchange the initial currency for the second.
► Exchange the second currency for a third currency.
► Then exchange the third currency for the initial currency.
Below you will see a clear example. In this case, we will use the currencies USD, EUR and GBP.
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Here are the steps of triangular arbitrage in Forex:
► Invest USD in EUR.
► Invest EUR into GBP.
► Finally, invest GBP into USD.
These are the benefits that operators and investors can receive with this triangular arbitration strategy:
► Receive benefits on large investments.
► The risk is considered to be minimal, although investment operations present it at the lowest level.
► It must be invested to generate profits. There are no troublesome issues.
It is possible to adopt this strategy in uncertain market situations to generate profits. In these cases, it is highly recommended to carry out operations in the short term, since it is possible to obtain benefits anyway.
On the other hand, it is not necessary to have a capital of a million dollars or open accounts in various brokers. You can make money with the statistical arbitrage strategy in Forex even with micro and mini lots, and a single trading account.
This pair trading arbitrage strategy (also called convergence trading) is based on statistics and what is known as reversal to the mean.
Your goal is to find 2 historically correlated currency pairs with the help of a correlation calculator. Subsequently, when the correlation between the 2 pairs diverges beyond a certain value, you will have to buy the weaker pair and sell the stronger pair.
In this case, when the reversal to the mean is present, the number of pips of these two operations will be positive.
Statistical Forex arbitrage requires a good perception of leverage, sound risk control,
It would be a mistake not to mention arbitration with Forex brokers. For traders, it is possible to take advantage of certain price discrepancies between 2 brokers from the same market.
For example, a broker A can offer a price of 1.4542, while a broker B shows a price of 1.4556. Broker arbitration is definitely fair, since it is the brokers themselves who offer the prices.
However, it is understandable that the worst priced brokers do not like traders who take advantage of their downside. Some clients of large retail brokers in the United States explain that some brokers offer different prices depending on their users.
In these cases, arbitration with Forex brokers would be a fairly profitable strategy, although it is not certain that such brokers allow you to keep your profits.
Retail brokers offer unified and aggregate pricing, so arbitrage of this kind is simply not possible.
And finally it is time to talk about Forex latency arbitrage. In this case, the trader takes advantage of an advantage in the network over the markets.
This can happen in several ways, although the general idea of this kind of arbitration is that an advantage in the network (speed) allows you to see the future.
Latency arbitration is practiced at both the institutional and retail level, and it appeared in 2007. Unfortunately, this strategy is not as feasible today due to the large number of people who use it, large computer companies and network infrastructure improvements made by the largest market participants.
The stance toward retail latency arbitration is divided and has caused much debate in different communities and forums.
You can find several developers selling their software on these forums, which use a “fast” and a “slow” broker.
However, this strategy involves the following dangers:
► If the “slow broker” is too slow, your winnings may be so large that you may not be able to withdraw them;
► It is possible that some network or software improvements allow the strategy to work for a time, but over time they lose their effectiveness.
Conclusion
FX arbitrage is a good niche that can be profitable for experienced traders and of course with huge resources. There are also many unpredictable events when operating with this class of systems.
Even with a considerable investment of time and money, coupled with unsurpassed research, you still would not be guaranteed any benefits, despite the fact that this is implied by Forex arbitrage systems.
It is wise to examine various strategies carefully before applying them to a live account. Maybe you’re lucky and the price will move in your favor, earning more than you bargained for.
However, things can also go against you and cause you losses in this “risk-free” method.
Therefore, you have to try to trade Forex responsibly.
