Currency markets, just as financial markets, have some imperfections — the same currency pair can be sold at different prices at the same time. Some traders capitalise on these deviations to make money during a process called currency arbitrage. Read further to understand the concept in detail
Traders usually make money, or look forward to making money, by buying stocks at low prices and selling them at high. The same principle is followed in currency trading as well. There is, however, one strategy – currency arbitrage — where traders buy and sell at the same time at different prices to make money from the variation in prices at which two transactions are carried out.
A currency arbitrage is one of the foreign exchange strategies that allow a currency investor to make money from different rates offered by brokers in different currency markets for the same currency pair. The traders who carry out arbitrage are known as arbitrageurs.
Exploiting difference in prices
This means there is a difference between the bid and ask price of the currency pair. As a matter of fact, currency arbitrage entails buying and selling the same set of currencies from an array of sources to make money from differential pricing. Usually the arbitrage involves buying and selling of two currencies and exploiting the difference in prices. However, some traders also carry out arbitrage of three currencies – which is also called triangular arbitrage.
It must be noted that with the advancement of technology, the gaps in prices usually do not stay for a long period for arbitrage to happen quite smoothly. Since the prices move rapidly, executing an arbitrage strategy is not simple and risk-free.
Conventionally speaking, currency arbitrage involves purchase and sale of two or more currencies simultaneously, rendering the arbitrage risk-free. But with the popularity of algorithmic trading, arbitrage is not a common, or at least risk-free, occurrence any more.
So, currency arbitrage is a forex trading strategy to make money in imperfect market conditions where the same set of currencies are being sold at different prices at the same time in different markets.