Arbitrage trading is a specific type of trading method usually suited to more experienced traders who have experience in using multiple exchanges. However, the reason that arbitrage trading is not for beginners is because of the strategy involved. Today, we will discuss arbitrage trading in more detail and precisely how it works within the forex market.
Thanks to technology and internet advancements, traders have been granted a platform that provides tools that work for thousands daily. The internet has brought traders together, allowing them to access more data and share news quicker. It has also facilitated the rise of multiple new exchanges and many pieces of arbitrage trading software, which have helped complement the trading methods of many, over the last few years in particular.
But what is arbitrage trading, how does it work and how can you use it to benefit your trading method? That’s something we’re going to unpack for you today and hopefully shine some more light on the topic for you.
Forex trading is the buying and selling of foreign currencies in the global foreign exchange market. Traders who operate in this market aim to make money by taking advantage of price movements in the market.
Most foreign currency pairs use the US dollar. However, you will also find a number of pairings that use the euro, the Canadian, Australian and New Zealand dollars, and the British pound. This type of trading involves speculating which currency will go up or down in value relative to another. One thing to note about the forex market is its sheer scale. Over any 24 hours, there are trillions of dollars’ worth of transactions taking place.
By analysing several variables, including economic indicators and political events, traders can gain insight into which currencies are likely to increase or decrease in value. Investors can do forex trading manually, but it is a very turbulent market for a beginner. You can also check out the best literature on investment topics to get a better picture of how the market operates.
However, many retail and institutional investors trade with the help of automated software programs. Moreover, a retail investor invests their own money, whereas an institutional investor is a large corporation like a hedge fund, pension fund or investment bank.
Automated software programmes cover a range of trading methods. They use computer algorithms to identify profitable trades and execute them accordingly. Many pieces of software also use algorithms and computing to perform arbitrage trading.
What is forex arbitrage trading?
Forex arbitrage trading is a strategy that uses incremental price differences across a range of exchanges to make money. Due to various complex reasons, different businesses may have slightly different prices for the same asset. As a result, arbitrage trading is a relatively simple process. However, the execution of the strategy with a forex broker is much more difficult in practice.
It involves buying and selling assets at different prices to take advantage of mispricing. Arbitrage trading aims to buy low and sell high, thus capturing a profit from the slight price difference.
By exploiting market discrepancies, traders can benefit from opportunities they may otherwise miss. As such, arbitrage trading can provide investors with a way to increase returns while minimizing risk.
The real skill comes from identifying which exchanges have these prices and managing to send your chosen foreign currency between the exchanges and selling them at a higher price. Currency arbitrage takes advantage of differences in exchange rates across different markets to generate profits. That is the definition of forex arbitrage trading.
Traders use various arbitrage strategies, such as triangular arbitrage, statistical arbitrage and currency arbitrage.
Triangular arbitrage involves exploiting the price differences between three different currency pairs to make a profit. Statistical arbitrage is based on the assumption that prices will eventually revert to their mean values, and trades are made accordingly.
These are just some of the different arbitrage strategies traders use today. By understanding these strategies, traders can gain an edge in the market and increase their chances of making profits from short-term price discrepancies.
However, it is considered a very specialist and specific area of trading. It isn’t generally a good idea for beginner traders to get involved in this type of trading immediately – finding your feet first is usually the best option.
Some analysts will point towards less complicated strategies such as swing trading, so that novice traders can build their knowledge and then move towards more complex methods such as forex arbitrage trading.