The forex arbitrage trading strategy is a method in which inefficiencies in the prices of trading pairs are exploited to make a profit. This is either done between 3 foreign currencies or taking advantage of price discrepancies across different forex brokers.
Fast Moving Trades
Whenever their are inefficiencies in any market, the price gap tends to close fairly quickly as arbitrage traders see profit opportunities. This characteristic requires that trader respond quickly to realize these opportunities. Accordingly, it is common to use forex arbitrage software to execute these trades in a timely manner.
In addition, you don’t have immediate access to software, you can easily find a forex arbitrage calculator online. This tool will help you identify price inefficiencies quickly and efficiently.
The fast moving nature of this strategy requires the currency trader to be sharp and light on their feet. That is why it’s probably a good idea to practice this method on a forex demo account until until your skills are honed enough to do this fast trade.
Low Risk Trading
Of all the forex trading strategies this is one of the lowest risk methods you will find. If you execute it correctly and quickly enough, it is essentially a risk-free trade.
You don’t hear risk-free very often when it comes to the foreign exchange market. But in this case, the real current prices are clear and you don’t have to rely on price movements in either direction to profit from this trade.
Although it is low risk, it is hard to come by. In addition, you may not be successful in all of your attempts for whatever reason. There is no forex arbitrage system that is fool proof and ones that will provide enough to live on requires a large trading account or incredibly high leverage. Very rarely do currency traders use this as their sole strategy. This can just be one of many other methods in a trader’s tool belt.
Arbitrage Trading Across 3 Currencies
Let me give you a simplified example so you can get the concept. Let’s say USD/CAD = 1.2, CAD/EUR = .7 and EUR/USD = 1.3. I can buy 1.2 CAD for 1 USD. With the 1.2 CAD I can buy .84 EUR (1.2 X .7). With the 8.4 EUR I can buy 1.09 USD for a $.09 profit.
Here’s how it might play out in real life. Let’s say USD/CAD = 1.1121, CAD/EUR = .6863 and EUR/USD = 1.3111. Now let’s say that you have a 100:1 leverage ratio on a $1,000 forex margin account. That gives you a trading power of $100,000.
With 100,000 USD buy 111,210 CAD, then with 111,210 CAD you buy 76,320 EUR (111,210 X .7). Then with the 76,320 EUR you can buy back 100,060. You make a 6 pip increase netting you a profit of $60 on this arbitrage trade.