What Is Arbitrage?

Arbitrage takes advantage of market inefficiencies and exploits short-lived variations in the price of identical or similar financial instruments in different markets or vehicles. Arbitrage trades are commonly made in stocks🧸, commodities, and currencies, but can be accomplished with any asset.

Understanding Arbitrage

Arbitrage can be used with any asset type but occurs most commonly in liquid markets such as commodity futures, well-known stocks, or major 澳洲幸运5官方开奖结果体彩网:forex pairs. These assets can often be transacted in multiple markets at once. Thi♓s creates rare opportunities for purchasing in one market at a given price and simultaneously selling in another market at a higher price. In principle, the situation creates an opportunity for a risk-free profit for the trader; however, in today's modern market, these circumstances could indicate a hidden cost not immediately apparent to the arbitrageur.

Arbitrage provides a mechanism to ensure that prices do not deviate substantially from 澳洲幸运5官方开奖结果体彩网:fair value for long periods. With advancements in technology, it has become extremely difficult to profit from pricing errors in the market. Many traders have computerized trading systems set to monitor fluctuations in similar 澳洲幸运5官方开奖结果体彩网:financial instruments. Any inefficient pricing setups are usually acted upon quickly, and the opportunity is eliminated, often in a matter of ওseconds.

Examples of Arbitrage

As a straightforward example of arbitrage, consider the following: The stock of Company X is tradin༺g at $20 on the New York Stock Exchange (NYSE), while, at the same moment, it is trading for $20.05 on the London Stock Ex🎃change (LSE).

A trader can buy the stock ♉on the NYSE and immediately sell the same shares on the LSE, earning a profit of 5 cents per share.

The trader can continue to exploit this arbitr🍰age until the specialists on the NYSE run out of inventory of Company X’s sto﷽ck, or until the specialists on the NYSE or the LSE adjust their prices to wipe out the opportunity.

A More Complicated Arbitrage Example

A trickier example can be found in Forex or currency markets using triangular arbitrage. In this case, the trader converts one currency to another, converts that second currency to a third currency, and ꦑfinally converts the third currency ba🎀ck to the original currency.

Suppose you have $1 million and you are provided with the following exchange rates: USD/EUR = 1.1586, EUR/GBP = 1.4600, and USD/GBP = 1.6939.

Wiꦗth these exchange rates, there is an arbitra✱ge opportunity:

1. Sell dollars to buy euros: $1 million ÷ 1.1586 = €863,110
2. Sell euros for pounds: €863,100 ÷ 1.4600 = £591,171
3. Sell pounds for dollars: £591,171 × 1.6939 = $1,001,384
4. Subtract the initial investment from the final amount: $1,001,384 – $1,000,000 = $1,384

From these transactions, you woul🐬d receive an arbit🌜rage profit of $1,384 (assuming no transaction costs or taxes).

The Bottom Line

🐻Arbitrage is a condition where you can simultaneously buy and sell the same or similar product or asset at different prices, resulting in a risk-free profit.

Economic theory states that arbitrage should not be able to occur because if markets are efficient, there would be no such opportunities to profit. However👍, in reality, markets can be inefficient, and arbitrage can happen. When arbitrageurs identify and then correct such mispricings (by buying them low and selling them high), though, they work to move prices back in line with market efficiency. This means that any arbitrage opportunities that do occur are short-lived.

There are many different arbitrage strategies that exist, some involving complex interrelationships between different assets or ൩securities.

Correction—April 9, 2022: A previous version of this article had miscalculated the complicated arbitrage example.