Forex arbitrage is a tricky but ultimately profitable strategy - if implemented correctly. It is not recommended for traders who are just starting out but should only be attempted if you already have some experience in the markets. In addition, you will also need to have a bigger trading bankroll since you will not be able to use leverage when implementing the strategy.
Arbitrage basically involves taking advantage of “pricing inefficiencies” or differences in the prices of a particular currency relative to other currencies. The basic arbitrage strategy is the ‘triangular arbitrage’ which involves first buying one currency for a second currency, exchanging the second currency for a third currency, and then selling it and collecting the profit in the initial currency.
To illustrate, lets say you start by buying euros in exchange for dollars. If the exchange rate of the EUR/USD is currently 1.1736 and you buy one-mini lot (10,000 units), you pay $11,736. Now, you sell your euros in exchange for the UK pound, with the exchange rate of the EUR/GBP at 0.7321. Thus, you get 7,321 pounds. Now, you end the arbitrage by selling the pounds for US dollars, at an exchange rate of 1.5634, or $11,445. Your net profit is $290.
One of the challenges of the arbitrage strategy is that the trading opportunities are only available for a short time. The reason for this is that by exploiting the price inefficiencies between currencies, you are also correcting them. Thus, you need not only act quickly but also have access to real-time currency price quotes. Fortunately, there are online forex arbitrage calculators that can help you quickly identify trades.
However, one of the major advantages of this trading technique is that you have less risk since you have no open trades as your long positions are offset by short ones when performing the trades.
To summarize the steps in performing arbitrage:
1) Find what currencies to use in your arbitrage. The three currencies you use should have correlating exchange rates, i.e. EUR/USD, EUR/GBP and GBP/USD as seen in the example above.
2) Get real-time exchange rate quotes. You should be able to get this on your trading platform provided by your broker.
3) Use the Forex arbitrage calculator to compute the arbitrage and find trading opportunities.
4) Implement the trades.
