Arbitrage trading strategy is the investors' continuous buying and selling gestures with profit-earning motives based on price differences. Traders here simultaneously buy stocks from one platform and then immediately sell them in another with a high asset value. The price difference between the buying and selling value across different trading platforms marks their net profit.
As the price difference is short-lived, traders must implement their actions within a few minutes or seconds.This strategy, though previously impossible, is now becoming increasingly accessible to traders due to massive advancements in technologies, including algo trading software. By fully automating the process, traders can easily exploit market price inefficiencies and trade with remarkable speed and accuracy.
As the price difference is short-lived, traders must implement their actions within a few minutes or seconds.This strategy, though previously impossible, is now becoming increasingly accessible to traders due to massive advancements in technologies, including algo trading software. By fully automating the process, traders can easily exploit market price inefficiencies and trade with remarkable speed and accuracy.
How Does Arbitrage Trading Strategy Work?
This trading strategy fully depends on the arbitrager's (trader's) ability to capitalise on the differences in the listed asset prices across various stock exchanges. But the difference remains only for a few minutes or seconds. Thus, to effectively analyse trading opportunities and to carry out the strategy traders use sophisticated software and tools like the options strategy builder.
- Arbitrage trading takes advantage of price discrepancies across multiple geographic regions. These mismatches in the prices of stocks of the same company in different stock exchanges occur mainly due to a lag in information. For instance, the Rupee vs Dollar ratio often changes, resulting in the misplacement of shock prices in foreign exchange and the Indian exchange market.
- Therefore, companies enlisted across different national and international stock exchanges are volatile to such discrepancies. Along with traditional stock arbitrage, cryptocurrency arbitrage is another profitable trading option for the swift market dwellers. Research shows that Bitcoin and ether derivatives which have options of >= 15 days of maturity are greatly becoming popular arbitrage strategies.
Due to the swiftness of action, arbitrage trading is suitable for only professional traders with profound knowledge of advanced trading software. Many prefer to use an options trading app to smoothly monitor the price ranges of stocks across different stock exchanges. However, arbitrage trading requires certain conditions to be fulfilled to be profitable for you.
Important Conditions for Arbitrage Trading
To be profitable with your arbitrage trading strategy you will have to use a very large amount of money at stake. As the price discrepancy is minimal between, without buying and selling a huge amount of stocks you can't make a considerable profit here. Therefore, you will have to create a custom trading strategy to leverage from arbitrage trading following the conditions;
- A Mismatch in the Asset Price: The same stock or asset needs to be traded at a different value in different stock exchanges simultaneously.
- Simultaneous Transaction: The arbitrager needs to buy and sell assets from one market to another simultaneously.
- Vigilant Observation: The opportunity remains only for a few minutes or even seconds therefore only the vigilant observers get the chance of arbitrage trading.
Due to these conditions conducting arbitrage trading is nearly impossible without using anyAlgo trading software. However, if you are confident, understand the various types of arbitrage trading before trying your hand at it.
Explaining Different Arbitrage Trading Types
There are three main types of arbitrages that you can try. These are;
-> Retail Arbitrage
This is the basic way of making an arbitrage that you can easily understand. Have you seen that the products available in online stores sell at a much lower price than those in physical stores? Third-party users often take this as an opportunity to profit.
They buy online at a cheaper rate and sell those products offline with a high note. This is a classic example of arbitrage. Here the buyer assumes the risk and uncertainty of acquiring an inventory as they remain unsure whether they will get to sell the product in their expected profit range or not.
They buy online at a cheaper rate and sell those products offline with a high note. This is a classic example of arbitrage. Here the buyer assumes the risk and uncertainty of acquiring an inventory as they remain unsure whether they will get to sell the product in their expected profit range or not.
-> Simple Arbitrage
This is the type of arbitrage you will see in the arena of the stock market. Here the trader simultaneously buys and sells assets on two different exchanges without the risk of storing stocks for the future. As the transactions are taken at the same time, the risk factor naturally decreases here unlike in the retail arbitrage.
Here the trader buys the stock using advanced tools like options strategy builder and sells it simultaneously on another exchange platform with a slightly higher asset value.
Here the trader buys the stock using advanced tools like options strategy builder and sells it simultaneously on another exchange platform with a slightly higher asset value.
-> Merger Arbitrage
It is the riskier of the three types of arbitrages. Merger arbitrage is a long-term process in which investors buy the shares of a company that is undergoing a takeover. They do it with the hope that the takeover will increase the asset value of the stocks and that they will profit from it.
However, as the price discrepancy is not prominent here, there is no guarantee of making a sole profit. Instead, traders can face a loss if they fail to sell the stocks after the turnover or if their resell value decreases. Also, their money remains stuck for a longer period.
However, as the price discrepancy is not prominent here, there is no guarantee of making a sole profit. Instead, traders can face a loss if they fail to sell the stocks after the turnover or if their resell value decreases. Also, their money remains stuck for a longer period.
Role of Arbitrage in the Forex Market
If you want to profit from arbitrage trading, the Forex or foreign exchange market is your best option. The forex trading market is decentralised as numerous over-the-counter or "OTC" trading occurs here through different global banks. This makes the forex market an ideal place for arbitrage trading.
Temporary price mismatches, which are very common in the forex market, favour the traders here. The exchange rate constantly fluctuates due to changing trends. Also, the abundance of liquidity enables traders to easily capitalise on minute price discrepancies before disappearing.
Temporary price mismatches, which are very common in the forex market, favour the traders here. The exchange rate constantly fluctuates due to changing trends. Also, the abundance of liquidity enables traders to easily capitalise on minute price discrepancies before disappearing.
Why Do Traders Do Arbitrage Trading?
This swift utilisation of price differences can benefit traders without direct investments. This often encourages traders to choose arbitrage trading. Other reasons include;
- Low risk due to simultaneous trading actions
- Sure gain of profit due to the evident price discrepancy
- The use of Options Trading App makes the process of analysing share prices easier for traders
Conclusion
To summarise, the arbitrage trading strategy deals with identifying price mismatches and leveraging profit out of them. With a large amount of capital and advanced trading software, you can easily gain profit here. If you too, are interested in this strategy, create a custom trading strategy based on your investment capacity and efficiency in trading.