Arbitrage in the world of finance refers to a trading strategy that takes advantage of irregularities in a financial market. Forex arbitrage involves identifying and taking advantage of price discrepancies that can arise in the valuation of one or more currency pairs. The general characteristic of real arbitrage is a “risk-free” profit, but achieving this result usually involves taking a certain degree of risk during the execution of the trade. Often, the risk of execution actually exceeds the small profit that arbitrageurs commonly take in.
There are many ways to profit in the forex market. Anticipating the future price movements of currency pairs is one of them, and arguably the most widespread among retail forex traders. Carry trades and accumulating rollover profits is also a popular trading approach, which is based on buying a higher-yielding currency and simultaneously selling a lower-yielding currency, making a profit on the interest rate differential. However, traders can also make profits with very low risk through forex arbitrage?
Forex arbitrage is a strategy that is used to exploit price discrepancies in the market. The concept was derived from the derivatives and the futures markets where a similar instrument because it is traded as a derivate often tends to show an imbalance in pricing. The main logic that determines arbitrage is the fact that security, regardless of where it is listed or traded should reflect the same price or value. When there is a discrepancy in pricing, it gives rise to a short term price imbalance which is taken advantage of by arbitrageurs.
Since arbitrage is a fairly low-risk strategy, arbitrage opportunities don’t last long on the market. The buying pressure on the lower-priced asset and the selling pressure on the higher-priced asset on different exchanges causes the prices to converge eventually. The advancement in technology and software helped large investors to continuously search for price discrepancies of the same assets traded on different markets, causing the arbitrage opportunity to disappear in a matter of seconds by increasing the demand for the lower-priced asset and increase the supply for the higher-priced asset.
Arbitrage opportunities often only exist for very short periods of time. If you see the opportunity, chances are others do too, and so the market tends to be self-correcting. Execution time on market orders becomes crucial to ensure that the prices you see are the prices you get — as you don’t want to accidentally lock in losses. If the market isn’t liquid, it can’t support large orders that let you maximize your profit. And if you have to wait minutes, even hours, on centralized platforms for your trades to settle, you’re exposing yourself to risk and headaches in managing your tokens.
