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Forex Arbitrage Trading Strategies
Written by: PaxForex analytics dept - Friday, 19 February 2016 1 comments
The foreign exchange market commonly referred to as the forex market is an international exchange for the trading of currencies. It allows investors from large banks to individuals and everyone in between to trade one currency for another. Each trade is both a purchase and a sale, as one currency is sold in order to buy another one. This duality means that currencies are not priced in any one currency but in relation to other currencies.
In the world of finance, arbitrage is the practice of taking advantage of a state of imbalance between two or more markets. Forex arbitrage is a risk-free trading strategy that allows retail forex traders to make a profit with no open currency exposure. The strategy involves acting fast on opportunities presented by pricing inefficiencies, while they exist. This type of arbitrage trading involves the buying and selling of different currency pairs to exploit any inefficiency of pricing.
Triangular arbitrage (also referred to as cross currency arbitrage or three-point arbitrage) is the act of exploiting an arbitrage opportunity resulting from a pricing discrepancy among three different currencies. A triangular arbitrage strategy involves three trades, exchanging the initial currency for a second, the
second currency for a third, and the third currency for the initial. During the second trade the arbitrageur locks in a zero-risk profit from the discrepancy that exists when the market cross exchange rate is not aligned with the implicit cross exchange rate.
In theory, identical objects would be the same price in different markets. However, market inefficiencies, usually in communication, result in different prices. Arbitrage takes advantages of these inefficiencies to profit the trader. Forex traders take advantage of price differences by buying currencies where they are less valuable and selling them where they are more valuable. In practices this usually involves multiple trades of intermediate currencies. Intermediate currencies are other currencies used to express the value of the currency you are trading.
Forex arbitrage is a good niche as it can be profitable for experienced and, of course, well-funded traders. There are many exceptional 'unknown unknowns' while trading these kinds of systems. Even having a substantial amount of time and money investment, mixed with unsurpassed research, you still don't have the guarantee of a benefit, though it is implied with systems in arbitrage in forex. It would be wise to examine various strategies carefully before applying them in the real practice of forex trading.