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Forex Arbitrage And Strategy

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What is an 'Arbitrage'?


A) Arbitrage stands for 'buying' in one market and 'selling' the same in another and gaining instantly. Arbitrage opportunity arises because of temporary difference in value.  Let it be clarified :-

Suppose 'onion' is selling Rs.20/- a  kg at Chennai whereas it is being sold at Rs.30/- a kg at Mumbai. Now, there is a fantastic opportunity of making an attractive profit if onion is bought at Chennai and instantly sold at Mumbai. Stock market traders always look for such opportunities to make easy profits free from risks. Price of either stock or currencies is always a moving factor and constantly fluctuating every second. Therefore, if the price of the stock is undervalued in one market and being sold at a higher price in another, a great opportunity of making gain arises.

The exchange rate is constantly fluctuating. Traders always try to exploit the opportunities of arbitrage by buying a stock on a foreign exchange where the price has not yet adjusted itself because of fluctuating exchange rate. The price of a specific stock may therefore be undervalued temporarily than the price of the same stock in another market.

Had all the markets of stock/forex been tuned in such a way that the price of a stock/currency would be same everywhere then the scope of 'arbitrage' profit would never arise but the case is not really so. Therefore, it may be said confidently the scope of making profit arises only because of different values/price of the same stock/currency in various markets at the same time.

Of course, not always a scope of 'arbitrage profit' arises even if there is a difference in pricing of the same goods in two different markets. 'Transaction cost' or some other charge may ruin the opportunity of making an arbitrage profit at any time. Imagine, in the above example if a transaction cost of Rs.11/- is imposed, the entire profit vanishes.

What is a forex arbitrage?


A) Forex arbitrage is an unique strategy followed by thousands of traders all over the world. Trading in arbitrage is different from traditional system of system of trading and is associated with unique challenges, risks and costs. To trade in this system requires 

  • A larger investment in hardware viz computers and network hardwares
  • In depth experience and calculation
  • All necessary support for checking and keeping record of essential/latest information updates

Strategies :

1) Arbitrage Currency Trading : This involves fast action in search for opportunities resulting from inefficiencies in prices. This includes buy and sell of various currency pairs aimed at exploiting these inefficiencies in pricing. Normally, traders follow two-currency arbitrate to exploit the differences between the spreads of two currencies.

A spread is actually the effective distinction between two instruments that are being closely monitored for possible arbitrage opportunities. Arbitrage calculators assist in locating opportunities very quickly and are easily available in the web. Some companies offer free trial of 'arbitrage calculators' on opening of an account with them. Two things are of utmost importance  to this style of trading :

  • access to real time pricing quotes 

  • quick response to act on these quotes

2) Triangular arbitrage in Forex : Triangular arbitrage is the method of converting one currency to another, then converting it again to a third currency and finally converting it back to the original currency quickly in a short span of time. It is a situation which may be described by the issues of disequilibrium in pricing strategies. An opportunity of making fast gain in 'triangular arbitrage' arises out of an imbalance in two or more markets.

A trader who trades in 'arbitrage' is called an 'arbitrageur'. Opportunities in triangular arbitrage never come frequently and last only for a few while till the imbalance in two or more markets stabilizes and comes at par. Hence, the arbitrageurs must have latest computer system and fast internet connection to keep knowledge of real time pricing quotes and make fast transactions online within a short period of time. Since this method involves three currencies it may be described it as follows:-


  • Investing currency A into currency B
  • Investing currency B into currency C
  • Finally, investing currency C back into currency A and earn the profit


Example of Triangular Arbitrage :



Suppose, a real time exchange quote on a specific day at a specific time is as follows :-

Here currency A is USD, currency B is EUR and currency C is GBP


EUR/USD : 0.8710    EUR/GBP : 1.4680   and   USD/GBP : 1.6940

  1.  Now if $1,000,000 is sold for Euros (1,000,000 X 0.8710 ) =  871,000 Euros

      2. Now 871,000 Euros is exchanged for GBP ( 871,000 / 1.4680 ) = 593,324.25 GBP


      3. Now finally, GBP 593,324.25 is converted back into USD ( 593,324.25 X 1.6940 ) =         $1,005,091.28




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