What is Arbitration?

Arbitrage is the strategy of identifying an instrument whose price differs in two markets, then buying it and reselling it at a higher price. Unlike traditional trading, which also involves selling at a price that is more expensive than the purchase price, in the case of arbitrage (at least in theory) we have the opportunity to trade at a higher price already at the time of purchase – without the passage of time – in another market/exchange.

What is currency arbitrage?

Currency arbitrage is a special case of arbitrage that takes place in the foreign exchange market. In practice, it means buying a given currency unit at a rate lower than the price for which we can sell the currency in another market. Since currency markets are among the largest, currency arbitrage has largely been automated in the 21st century.

What does automatic arbitrage consist of?

Automatic arbitrage is the making of trades in two or more markets by a computer when an opportunity to make money on a given trade through arbitrage is spotted. The introduction of such mechanisms – especially in developed financial markets – has made the opportunity to make money through arbitrage almost impossible to spot in practice. All such moments are exploited within milliseconds by computers. At the same time, their use of such strategies causes stability in financial markets.

What is tripartite arbitration?

Triangular arbitrage involves taking advantage of differences between buying and selling prices for at least 3 assets. It is worth using an example from the foreign exchange market here. A trader takes possession of the zloty (PLN) and sees that by buying Euros (EUR) for US dollars (USD) he will have the opportunity to make money. So he makes an arbitrage using 3 different currency pairs.

Is it possible to make money on arbitration?

In the case of developed markets such as foreign exchange, commodities or the stock market, it is very difficult to find a situation in which arbitrage is profitable because of trading machines. The situation is different in less regulated markets – here there are opportunities for arbitrage but they often involve high risk.

What are the risks associated with arbitrage?

While arbitrage appears to be a way to make a sure profit, there are often some risks associated with it:

• Lack of liquidity in the market (will result in not selling assets at the expected price)
• Transaction costs (which can reduce profitability)
• the time of transfer of assets between exchanges (the price may change over time as we transfer assets to another exchange)