Arbitrage In The Forex Market

Arbitrage under a yellow Tap measure

Definition

Arbitrage is the simultaneous buying and selling of the same asset in different markets in order to profit from tiny differences in the asset’s listed price. It exploits short-lived variations in the price of identical or similar financial instruments in different markets or in different forms.

There are basically two types of arbitrage which are  a) Futures arbitrage

b) Dividend arbitrage

The Circular nature of Arbitrage in Trading

Requirements for Successful Arbitrage

• The instrument should trade at different prices and rates at the same time
• All costs and fees must be included in the total expenses
• The arbitrageur must simultaneously execute both trades, no time lapses
• Difference of prices with similar cash flow

Risk associated with arbitrage

Rates fluctuations

Depending on the volatility speeds of the market, the exchange rates of currencies will always be changing constantly posing a risk of loss, an arbitrageur faces the risk of losses if there is a devaluation of the currency suddenly, where he has to sell the stock or instrument

Execution Risk

If an arbitrageur enters into multiple trades at a time, there is a high risk that while closing one position, there is a price convergence in his other deal, and his chances of making a profit are over. He may even incur a loss due to transaction charges.

Incapacitation of Buyers

There are many instances when a buyer backtracks or is not in a position to fulfill his financial commitments. In such cases, an arbitrageur may incur substantial losses. For example, if he purchases commodity A from a market and the buyer in the second market backtracks and denies to buy, he will get into serious trouble. If the prices of the commodity fall before selling, or the funds may remain blocked

News or Fundamentals

Right in the middle of the trade it may occur that news is released or an economical statement or paper of some sort which will impact global politics and or an economic situation of a country, it will impacts the rates either in a positive or negative manner then when it happens for instance if the odds of a supply of the currency or commodity is changed the buy trade may get into a loss that over weighs the sell by far.