Arbitrage is a forex trading strategy whereby traders buy and sell the same currency pairs to take advantage of the discrepancy in prices in different financial markets. The practice of buying and selling goods or services on speculation has been in existence since time immemorial. For instance, purchasing an asset may be comparatively cheaper than when you sell it, depending on the market principles of supply and demand. However, it is not as simple as quoting a higher value for the asset you have in hand because there are thousands of players in the forex market. Your forex trading strategy depends on being smarter and having access to the latest information and technology.
Forex arbitrage is a strategy whereby traders simultaneously seize upon momentary glitches to trade several currency pairs in the same market or different markets.
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The volatility and liquidity of the forex market make it an ideal harvesting ground for arbitrage trading. Since forex trading is decentralized, no need is perfect, and prices of currency pairs such as EUR/USD can vary in multiple institutions creating arbitrage opportunities. Arbitrage helps reduce price discrepancies as traders hike the demand by jumping into the fray when undervalued currency pairs.
In this post, let us explore how to use an arbitrage strategy in forex trading. The three main types of forex arbitrage are two-currency arbitrage, covered interest arbitrage, and triangular arbitrage.
Two-currency arbitrage is trading the same currency pair with two different brokers to exploit the price difference. It is simply buying a currency pair in an exchange that offers a lower price and then selling the same team in another exchange at a higher price. It is possible to have accounts with two different brokers, and they offer a slightly different price for, say EUR/USD. A trader could buy euros from a bank and then immediately sell those euros to another bank to make a quick profit. However, the strategy depends on acting fast before other traders notice the difference and institutions adjust their pricing to correct the anomaly.
Covered interest arbitrage exploits the interest rate differential between two currencies by using a forward contract as insurance to mitigate risk. It enables the trader to lock in an exchange rate in the future while buying currency at the prevailing rate. For example, when you invest US dollars and realize that the interest rate in the eurozone is better than rates in the US, you can convert dollars into euros. Then organize a forward contract with a fixed exchange rate on EUR/USD to hedge against changes in the exchange rate over the investment period. Once you realize the interest rate payments on euros are rising, you can convert your euros into US dollars to enjoy reasonable savings.
There are plenty of forex arbitration strategies, but you have to look at low-risk methods as much as possible while giving you a decent profit. Another common approach is the triangular arbitration strategy, which uses three currency pairs. It is more complex than two-way arbitrage, but the basic process is the same. It consists of a forex trader exchanging three currency pairs at the three different banks. This strategy won’t work if all three currency pairs are traded at the same bank because the bank would ensure they are running a good pricing system. For example, when a trader opens three positions with USD, EUR, and GBP, and starts buying 10,000 euros for 11,000 USD. The exact amount of euros is sold for 9,000 GBP in the second position. Finally, the British currency is sold for $11,054. In the process, the trader has earned $54, which is called triangular arbitrage.
Another method called statistic forex arbitration is different from the other strategies mentioned above. It is the method of tracking underperforming currencies and buying highly rated currencies. You have to remember there is no universal method of measuring currencies. There are many indicators or formulas to arrive at the value of currencies, but traders can use the Purchasing Power Parity data as a yardstick to assess currency exchange rates.
Arbitrage may seem like an easy and profitable plan on paper, but it is more complex in practice. The most significant risk is the timing of the trade. When you open and close multiple trades, it has to be done with precision. Meanwhile, the rewards and opportunities are more significant. Still, you also need considerable funds to play the game of leverage and maximize your profit from minor discrepancies of the same currency pair.
also read: https://newstimeusa.com/5-things-to-know-before-you-start-using-okex-exchange/