The Important Technicalities of Arbitrage Trading That You Should Know

Arbitrage Trading

Editor’s Note: This article was originally published on Digital Journal, and has been translated into English.

Synopsis: Arbitrage trading provides low-risk benefits to traders who are able to key into this strategy and make it work. However, it is important that traders understand the different types of arbitrage and how they are carried out in forex and cryptocurrency, first. Even experts acknowledge that a keen acumen is required to take advantage of the difference in prices available for the same asset being offered on different exchanges.

Understanding Currency Arbitrage

Simple arbitrage

In terms of Forex, an example would look like this:

Exchange A is selling €1 for $1.5 and buying €1 for $1.8

Exchange B is selling €1 for $1.8 and buying €1 for $2.1

Here, a savvy trader could buy Euros from exchange A, which is selling at a much lower price at $1.5, and immediately sell these Euros on exchange B for much higher. The same can be said in an example from an Alpha Roc report:

Exchange A is selling 1 ETH for 0.021 BTC and buying 1 ETH for 0.024 BTC

Exchange B is selling 1 ETH for 0.024 BTC and buying 1 ETH for 0.028 BTC

In this example, according to the report, a trader could purchase ETH from the first exchange (exchange A), as it is selling it for a lower price, and then move immediately to sell the ETH to exchange B for the higher price stated.

If the trader makes this trade with 10 BTC, they could quickly earn a profit of 3 BTC in no time. However, for this to be successful the trader must act fast. When they spot such discrepancies in an exchange, if they don’t move quickly, another trader will spot this arbitrage opportunity, the market will adjust the pricing immediately, and the opportunity will be lost. One of the reasons why arbitrage trading may not be ideal for beginners is because of the speed and attention required to execute this strategy successfully.

Triangular arbitrage

To help you understand this type of arbitrage better, consider this forex-related example.

A trader chooses to start with US$1million to trade with the following exchange rate: EUR/USD = 0.8631, EUR/GBP = 1.4600 and USD/GBP = 1.6939.

Using the exchange rate above, a triangular arbitrage works this way:

Sell USD for EUR: $1 million x 0.8631 = €863,100

Sell EUR for GBP: €863,100/1.4600 = £591,164.40

Sell GBP for USD: £591,164.40 x 1.6939 = $1,001,373

If you subtract the initial investment from the final amount: $1,001,373 — $1,000,000, you will get $1,373.

From these transactions, a trader would receive an arbitrage profit of US$1,373, assuming that there will be no taxes or transaction costs. As mentioned before, it will take time for novice traders to understand the technicalities of arbitrage trading.

How Arbitrage trading is used in Forex and Crypto

Forex arbitrage

Cryptocurrency arbitrage

The Bottom Line

But with any form of trading, it is important that time is set aside to study this strategy before seeking to gain profits. Reaching out to experienced traders and brokers to gain key insights from their respective methodologies is always encouraged.

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