Forex trading has gained quite a reputation among the investment community. In fact, it is the most popular form of trading among investors globally attracting an average trading volume close to $5 trillion. This number shows how promising making an investment is and by using the right tools investors can fully take advantage of this opportunity. Arbitrage is one such tool. We will look at what it is and the role it plays in helping investors make fruitful investments.

 

Contents:

Explaining Arbitrage with an Example

What Role Does Arbitrage Play in Forex Trading?

Identifying the Advantages & Drawbacks

Benefits of Arbitrage in Forex

Cons of Arbitrage Forex Trading

Final Thoughts

 

Explaining Arbitrage with an Example

Arbitrage is a relatively old term that has been in use since the late 18th century. It was coined by a French merchant and basically means taking full advantage of the price difference of an asset in different markets.

 

This distinct difference in pricing offers businessmen and investors the opportunity to buy an asset at a cheap price in one market and sell it at a higher price in another. As such, they stand to create a profit for every asset they buy.

 

Arbitrage can be used with raw materials, securities and in our case currency. Let’s look at an example of how arbitrage works in a simple setting. Imaging vehicle X costs $10,000 in your country and costs triple the price in another country. By using arbitrage, you can buy that vehicle in your country and resell it to another for a profit. This profit is determined after factoring out all the expenses you would have to make to make sure that the vehicle gets to the other country.

 

What Role Does Arbitrage Play in Forex Trading?

Now that we have a clear understanding of arbitrage, what’s its purpose in Forex trading? The idea of arbitrage in the trading of commodities and currency is basically the same. At any given time, the value of an asset is different when various forex markets are considered. Investors take advantage of this and buy assets from one market and sell it on another making a profit in the process.

 

Investors by currency one minute and resell them the next. At this rate, investors can make numerous transactions in one day maximizing their gaining potential. One of the biggest determining factors of the success of arbitrage in forex is identifying assets with price differences on different markets. However, this obstacle is slowly becoming less problematic thanks to the rise in technology. Investors now have special software designed to identify price discrepancies. With tools like Finage Real-Time & Historical Forex Market API, you can get global Forex Data all in one place, so you can access a full selection of data. Finage offers you more than 1300+ forex data as real-time. Investors have it in their arsenal to quickly identify prospects and take quick action.

 

The triangular forex arbitrage is gaining more traction among investors today. With this strategy, you can take full advantage of the price difference between three different currency pairs. Investors can start with euros, which they then convert to the US dollar. The resulting amount could then be converted to the Canadian dollar and eventually back to euro. The final amount in euros is always higher than the amount you started with.

 

Identifying the Advantages & Drawbacks

To fully understand the concept of arbitrage in foreigh exchange, we must proceed to look at its pros as well as some of the pitfalls arbitrageurs may encounter. Let's look at the more common ones below.

Benefits of Arbitrage in Forex

Investors know that they should always be ready for unfavorable times. Not every investment you make will generate profit and this risk involved is enough to dissuade many individuals from making investments in the first palace.

 

Arbitrage is one of the best strategies to apply in your trading as it is low-risk in nature. Investors take advantage of price discrepancies meaning they can always generate profit as long as they can find the right markets.

 

Cons of Arbitrage Forex Trading

The success of arbitrage in forex trading depends on your ability to identify price differences of an asset between markets. Without this ability there is no opportunity to take advantage in the first place. Another issue with this strategy is that it's popular, meaning the competition is aggressive. One you have identified a pair, you should keep in mind that there are chances that other investors have as well. In this case, every second becomes important putting extra stress in the equation.

 

To counter this, many investors have relied on special software that helps them to identify price differences in as little time as possible. Additional software that isn’t usually free.

 

Final Thoughts

Forex trading is a booming industry that provides opportunities for many investors. That being said, the generation of profit is not guaranteed. Much of this lies in what kind of strategies and tools the individual investor decides to use in their operations. But arbitrage has opened more doors for forex traders. A low-risk strategy that when applied in the right conditions will lead to constant profit generation.