All You Need to Know About Forex Arbitrage

Forex currency exchange or forex market is all about volatility and flexing the might of transactions that goes beyond USD 6.6 trillion a day. It is higher than the combined GDP of several underdeveloped nations. Also, many nations only two countries are ahead of it in their yearly GDP, USA and China. So, that’s explicitly huge liquidity. Thus opportunities are bigger in that sense. Forex arbitrage or currency arbitrage helps you gain profits. 

What is forex arbitrage? 

Forex arbitrage is considered one of the risk-free trading strategies by several traders. Retail forex traders can make huge gains without any currency exposure. The strategy involves initiating opportunities offered by inefficiencies in the small window they exist. 

However, this type of trading includes selling and buying various currency pairs for exploiting pricing inefficiencies. 

The event of exploiting the inefficiencies of the pricing will correct the issue. Therefore, you should be ready to take steps quickly with arbitrage strategy trading. That’s the reason you do not find these opportunities hinging for a long time. Hence, it is important for a trader to make profits and exit from the market to again enter at a reasonable price. 

You need the availability of real-time quotes of pricing and the ability to act swiftly, because delay would mean you’ll incur losses. Even more, you can use forex arbitrage calculators to help you with the opportunities in a short period of time. 

In a nutshell, when a trader earns profit through different in quoted price compared to the exchange rates movements, it is forex arbitrage. 

What is a forex arbitrage calculator? 

Traders have several opportunities available in tools that can help you locate inefficiencies, that is often time-consuming. One such tool that gives you a hike in trading is the forex arbitrage calculator. It provides immense opportunities to retail traders and offers them a chance to real-time forex arbitrage. 

Third parties and forex brokers are involved in buying and selling these calculators. However, it is important that you try your hand on a demo account. Brokers like InvestFw, PrimeFin, and others offer practice accounts. 

They put the handsome amount in your demo account using which you can try various tactics to apply forex arbitrage strategy and see how the market behaves on your investments. By learning multiple ways of trading, you can become a forex trading unicorn. You’ll get to experience the software of that particular broker. Also, not all brokers allow trading in a similar way. 

So, practising on a broker selected by you before trading in the financial market is a mindful thing. Also, a trader has the opportunity to gauge the market by doing sample trading. There are multiple forex pairs and currencies that traders can invest in and earn money. 

What is cross currency exchange? 

When there’s no presence of the US dollar and despite that two or more currencies trade or participate in exchanges, that process is called cross currency exchange. The divergence opportunities occur from the quoted price of currency pairs. 

Forex arbitrage strategies 

While you trade forex, there are many strategies that you can use for garnering profits. That helps in enhancing the profitability quotient. In these strategies, you need to look at different at the price difference between several combinations of trading instruments. There is plenty of forex trading arbitrage. Some of them are:- 

• Triangular arbitrage 
• Statstical arbitrage
• Spot-future arbitrage
• Interest rate arbitrage

Triangular arbitrage 

 In the triangular arbitrage strategy, a trader tries to exploit or work on arbitrage opportunities or chances that are available among three different currencies in a currency exchange market. The execution of arbitrage happens through consecutive exchanges. Here, one currency is exchanged with the other. It takes place when there are some discrepancies in the given currencies’ quoted price. 

The occurrence of arbitrage chance happens when the cross-exchange rate does not match with the exchange rate of a currency. Meanwhile, the price discrepancies generally take place when one market is undervalued while another one is overvalued. 

Meanwhile, the nature of currency exchange markets curbs the discrepancies in prices between different currencies to mere few cents. Sometimes it is reduced to just a fraction of a cent. Thus, in a triangular arbitrage, you’ll see a large amount of money being exchanged by traders due to several factors. 

For amplifying the profits, people use margin trading in it. Therefore their gains get doubled or even more in a short time. However, it is important that a trader takes care of the transaction costs because that can eat their profits. 

Statistical arbitrage

Statistical arbitrage forex strategies are market neutral. Here, both positions, long and short open simultaneoulsy for taking advantage of ineffective pricing in different but related securities. For example, if a fund manager thinks that product A is undervalued and product B is overvalued, he will take a long position in product A. At the same time, the buyer will take a short position in product B. 

Interestingly, investors refer to statistical arbitrage as pairs trading, especially in the forex trade. 

PS:- Consider these products as two different currencies while reading the example. 

You can apply the stastical arbitrage to a group or related currency pairs or securities. 

Risks associated with statistical arbitrage 

In the financial market, there’s no strategy or planning that does not involve risks. However, the problem only persists when you are not consistent and patient, or there’s something unforeseen. It primarily depends on the potential of the predicted normal price or historical price to return. It is commonly known as mean reversion. 

However, two currencies that trade in the same industry may not remain correlated for a colossal amount of time. There may be several macro and micro factors associated with that.

Moreover, statistical arbitrage tries to take profit from high-frequency trading. Thus, the risk rises by manifolds during trading. Traders try to take advantage of small inefficiencies that result in risks sometimes. 

Interest rate arbitrage 

Every nation has different interest rates that depend on economic cycles, and help in creating opportunities for investors. In addition, there’s a possibility to earn from the difference in interest rate in different countries. It is not so common strategy. 

The covered interest rate arbitrage is the most common one help traders make one of the biggest gains in a short time. Thus, the benefit is huge while trading through interest rate arbitrage. 

When using the forward contract to hedge the risk, of the exchange rate, interest rate arbitrage occurs. However, if there’s any sharp movement, the market may erase or eradicate the entire profit earned during the exchange of interest rates. 

Hence, for ignoring the risk, investors agree on a deal to set the currency exchange rate for the future. 

Potential risks involved 

Come what may, you’ll have to face risks while putting interest rate arbitrage into perspective. Tax agreements and Cohesive regulations result mostly in profit losses. 

 Some of the perils, that a trader needs to put into consideration are:- 

• Foreign exchange controls
• Transaction costs can be higher 
• Inelasticity of supply and demand 
• Different treatment for taxation
• Slippage during execution

Challenges in forex arbitrage

Like all financial markets, forex trading is not far from challenges. A trader has to make many adjustments to do better in the foreign exchange market. The rapid execution, market correction, and lack of information are some of the burgeoning challenges that keep on challenging market players. 

Forex arbitrageurs have to look into the market quite keenly to get better of problems occurring frequently. 

Interestingly, some experts consider arbitraging to be risk-free. However, that may seem easy on a piece of paper, the practicality of it is better faced by arbitrageurs. 

There is a risk of a price reversal, and slippage. Thus, forming a strategy does not mean you have won the battle in trading. However, traders have to go through huge execution risks, which can be a little tough at times. 

Moreover, in the forex arbitrage market, opportunities or chances appear and disappear quite quickly. So, a trader needs to be pretty quick and on toes to grab the opportunity as it arrives in the forex market. 

The market mechanism is another kind of risk that people or traders might have to face. There is a stage when the market starts correcting itself. It happens when too many market participants try to implement their arbitrage strategy. It narrows down all the profits to the limit that trading remains no longer profitable for traders. 

Interestingly, due to the corrective mechanism, undervalued and overvalued currencies converge at the mean. Thus, forex arbitrage becomes a game for quick fingers. You should push your bids swiftly to make whatever profit you can during the course to capitalise on chances offered by the market. 

Spot Future Arbitrage 

In the spot future arbitrage of forex, a trader buys currencies or currency pairs at the current market price and after earning some profits short or sell at the future price as per the set goal. So, that defines spot future arbitrage. Moreover, this type of trading is also known as cash and carry trade.

Meanwhile, in the reverse spot futures arbitrage or cash and cash trade, market participants short in the spot market and later on open a long position. That happens in the futures market. 

Know about pure arbitrage

In the pure arbitrage strategy, an investor simultaneously sells and buys currencies in different markets and seek the advantage of price differences. Moreover, so that experts use the term pure arbitrage and arbitrage synonymously. 

Notably, several investments can be bought from one market and sold into the other. Thus, it opens the perspective of earning money in different ways. When there are price discrepancies in the forex market, pure arbitrage is bound to take place, provided a trader has a plan in place. 

Thus, pure arbitrage is a strategy where a trader tries to take advantage of price inefficiencies in the forex market. 

However, with the growing use of technology, it has become increasingly difficult for market players to seek the advantage of pure arbitrage. Due to the placement of computer systems, now, any discrepancy is caught within fractions of seconds. So, investors have to find other ways to  

Conclusion:

Forex arbitrage is an important aspect of forex trading. You cannot become a successful forex trader unless and until you get better at arbitraging strategies. Several brokerage firms provide the facility of arbitraging provides an opportunity for subscribers to earn good profits. You can use financial service providers like InvestFW, PrimeFin, and others. Before you apply, study and research well about forex arbitrage.