Forex arbitrage is a form of risk-free trading whereby traders profit from price discrepancies in extremely similar pairs without any currency exposure. These arbitrage positions exist for only short time windows, therefore, one has to act fast to profit from them.
Let’s take an example:
Start with $100,000.
Sell $100,000 USD in NY and get 116510 of CAD (multiply by 1.1651 CAD)
Take 116,510 CAD to Frankfurt. You’ll get 130212 CHF (1 CAD = 1.1176 CHF)
You take that 130212 CHF to London and sell to get 100100 USD (1 USD = 1.3008 CHF)
Since you started with $100,000 USD, your profit = $100.
Types of Forex Arbitrage Strategies
1: Forex Triangular Arbitrage
This type of arbitrage looks for differences in currency exchange rates. The strategy focuses on three currency pairs extremely close to each other like the EurUsd, GbpUsd, and EurGbp.
In this, the profits you earn depend on how quick you are at selling the pairs at the highest price point you’ll get.
2: Forex Swap Arbitrage
Unlike in the triangular, swap arbitrage aims to provide differences in a swap from different forex brokers. The prices are always moving fast so you’ll need to have the best prices for you to earn substantial profits from this.
3: Forex Statistical Arbitrage
Statistical arbitrage focuses on the statistics that prices are likely to correct themselves in the future. The strategy aims to identify a basket of overperforming pairs and those underperforming because over time price reverts to its original mean average.
Arbitrageurs (people who practice arbitrage) sell the basket of overperforming pairs and buy the basket of underperforming one.
Risks of using Arbitrage Strategies in Forex
Contrary to popular belief, arbitrage strategies are not risk-free. Transactional and slippage costs can easily eat up the little profits that you could potentially earn from this type of trading.
1: Arbitrage trading is a game of speed
The fastest person to execute positions at the best prices is always the one who takes money home. If you’re not quick to identify those windows of time, you will earn virtually nothing.
2: The more people who spot the windows, the lesser the potential profits
The market is always fair game and tries to balance all levels. This means that the more people who identify and practice arbitrage trading, the lesser the difference in price which leads to little or no profits. In periods with several arbitrageurs, it’s possible to earn nothing.
3: A little slippage, no profits
Slippage is the difference incurred when you experience a little delay while transacting on the pairs or swaps. A slippage of little nanoseconds can cost your entire profits. This is because arbitrage trading is only available in windows of only a few seconds.
4: You’ll require arbitrage software
Due to the fast execution speeds to be required for arbitrage, and also the short time slots available, most arbitrageurs use software to help in their trading.
They are institutional traders who have a wide array of tools to help in their trading. Institutional traders have with them faster sources of news, better trading equipment, and even more advanced arbitrage software at their disposal.
As a retail trader, you’ll need to invest in high-quality software that will provide you with quick speeds of execution.
Types Of Forex Arbitrage Software
1: Automatic Trading Software
With automatic arbitrage trading software, you’ll only need to link it with your trading platform and it’ll identify those opportunities and also execute the trades for you instantly.
2: Alert Software
For those who don’t like software completely running their accounts, alert software provides push notifications to you when they spot trading opportunities then you’ll decide whether to trade them or not.
3: Remote alert software
Remote alert software pushes you notifications from another computer that could be far away from you. This is specially designed for traders who subscribe to this service from other traders. Like the alert software, once you subscribe you’ll receive notifications with every trading opportunity then it’s your choice whether to open a position or not.