What is Arbitrage In Forex
There are other ways to profit in trading without having to guess the direction of price movements, namely by forex arbitration.
In forex trading, the way to get profit usually is to anticipate the direction of price movement in the future. However, there is actually another way to profit without having to guess the direction of price movements, commonly known as market-neutral strategy . One of them, Forex Arbitrage (arbitration forex).What is arbitration in forex?
The meaning of arbitration in forex and in the world of financial trading is different from the use of the term arbitration in law ( jurisprudence ). Arbitrage is a means of trading in which traders seek to profit from price differences between instruments in two different markets. In English, the user arbitrage strategy trader is commonly referred to as ” arbitrageurs “.
Arbitrageurs usually buy in one market while at the same time selling in the same number of trading sizes in other markets, with the aim of reaping the benefits of the difference between prices in both markets. This is possible because the same products (assets / instruments) can be traded at different prices in different locations.
For example, several companies are registered in more than one stock market, even multinational companies can be listed on the stock market in several different countries. Theoretically, the stock price should be in the same range as it comes from the same company. However, the fact is that the flow of information does not flow at the same speed to all parts of the world and the market does not always function fully efficiently. Therefore, the stock price for a single company is not always the same in different stock markets.
People who know that there is a price difference can buy the stock in the lower-priced market, while selling in the stock with a higher price position. Thus, the profit will be locked.
Arbitrage In Forex
If so, how to do arbitration in forex?
Traders who want to do arbitration in forex basically do the same; they buy on a currency at a broker that gives a lower price, while at the same time sell at a broker who gives a higher price . After deducting the transaction costs, the profit is the remaining difference between the two prices. The trick can vary, but the point is trying to take advantage of price anomalies.
Forex arbitration practices include strategies that are often run by hedge fund companies and forex trading actors at the institutional level. However, rarely do it at the level of retail traders. Besides because the prices among retail forex brokers are more or less the same, also because not a few retail forex brokers prohibit the use of arbitration.
There are several ways that can be done when this strategy is allowed or possible to run . The first way is to do a forex arbitration between two brokers that give different price quotes for a currency pair ( Broker Arbitrage ). While the second way can use Triangular Arbitrage which is similar to hedging.
In its simplest form, forex arbitrage is done by buy and sell one pair in the same two brokers that give different price quotations. Here’s a sample provided by profitf.com:
Note that the price difference only occurs within a few seconds, and that also does not take into account the spread or other trading costs. To do the Arbitrage Broker strategy, a trader must be able to act as fast as lightning.
Before reviewing the Triangular Arbitrage, we first need to understand some basic concepts of forex first.
In forex trading, when we buy a currency pair, for example EUR / USD, we basically buy the first currency (EUR) while selling the second currency (USD).
Meanwhile, the synthetic or theoretical value of pair cross is indicated by the exchange rate of the two currencies in it, versus the US Dollar. For example, if EUR / USD is at the price of 1.1505 and GBP / USD at 1.4548. The implied value for EUR / GBP will appear by dividing 1.1505 with 1.4548, or (1.1505 / 1.4548 = 0.7908).
This is because currency pairs can be considered like fractions with denominators and numerators. So, EUR / USD x USD / GBP = EUR / GBP x USD / USD = EUR / GBP.
Well, if the EUR / GBP price value is different from the value implied in major EUR / USD and GBP / USD pairs, then it raises the opportunity for forex arbitration.
Here, Triangular Arbitrage consists of three trading positions .
Suppose EUR / GBP is at the price of 0.7911, or higher than the implied value, then we need to sell this pair. At the same time, we also need to open two trading positions in EUR / USD and GBP / USD pair, to create the opposite position for EUR / GBP.
This can balance risk and lock in profit. However, because the difference in price is very small, then we have to trade in large sizes so that the profit is good.Moreover, the charge swap for overnight position can instantly erase the profit gained.
For more details, an illustration on Wikipedia illustrates how a trader at Citibank (one of the top forex dealers ) conducts a Triangular Arbitrage after seeing the difference in price between the price quotes for the three currency pairs at Deutsche Bank, Credit Agricole, and Barclays.
Risk of Forex Arbitration
Some say that with forex arbitration, profit can be locked without risk (risk-free trading). This is not entirely true. If the culprit is a large (institutional) trader or hedge fund company, perhaps this is the case, because they have the ability to create High-Frequency Trading (HFT) and robots that can automatically trade simultaneously in various markets. However, the execution of forex arbitrage raises an important issue for ordinary forex traders, that is how to execute instantly. In addition, a slippage of only a few pips can directly wipe out a profit opportunity.
Of course, that does not mean forex arbitrage is not possible by ordinary traders. Now many forex trading robots (expert advisors / EAs) claim to use arbitration techniques to get profit with a low drawdown. If you are interested in using such arbitrage trading software, it is worth looking at some other risks.Among other things, the risk of a scam (a trading robot also has a scam), whether the type of arbitration being executed is a Triangular Arbitrage or an Arbitrage Broker, and also whether the broker you use allows the arbitration technique used by the robot or not .
Note that the dealer broker can thwart the order execution unilaterally, so it will be a high risk to run a Triangular Arbitrage at a broker like this. It could be one position executed when the other two fail. Meanwhile, brokers in general (both bookies and not) may not all mention forex arbitration at the Terms & Conditions available, so you may have to ask for an explicit statement from CS brokers about whether arbitration is permitted or not.