Arbitrage trading is a risk free way of making money by tapping into gaps that may occur. Theoretically, arbitrage trading can be done in forex by enjoying the fractions of pips that are missed in crosses. Here’s how it works – in theory. In practice, remember that forex trading isn’t easy money.
Did you ever try to calculate the price of a cross pair by yourself? Crosses such as GBP/AUD or NZD/CAD don’t necessarily appear by default on your site’s quote list. But even for popular pairs, did you see the full triangular connection? Sometimes a pip or more are missing:
At the time of writing, EUR/USD is priced at 1.3339, GBP/USD at 1.5343 and EUR/GBP at 0.8688. Buying a standard lot of 100,000 pounds would cost 153,430 dollars, according to GBP/USD. These 100,000 pounds could be sold for euros, according to EUR/GBP and get the trader 115,101. Now these euros could buy back 153,533 US dollars.
So, all in all we paid 153,430 and got 153,533 back – a profit of 103 dollars. If this kind of trading is risk free, why settle for one standard lot -why not 10 or 100?
One of the reasons for these gaps is that the representation for the crosses isn’t complete – if you make the calculation by yourself, you’ll see many more digits – these fractions of pips make the arbitrage gap. Some brokers take this into consideration and show more digits, narrowing down the gap.
And when the gap is narrow, the broker’s revenue kicks in. This gap may be filled by the spreads – try calculating the cross by using the correct bid or ask values, and you might find that there’s no arbitrage – such a deal will always lose.
The same applies for brokers that charge a commission for every deal – the commission may erase your theoretical profit.
Even if you’ve identified a genuine gap, are you quick enough to act? Probably not. Even if you use some kind of signal service to give you an alert ons such an arbitrage opportunity, you might blink and miss your chance. There are many forex arbitrage calculators out there – you be careful with them.
Another option is that you might be lucky and the price moves with you – making you a bigger profit than expected. But it might go the other way and cause you loss in this “risk free” method.
Another note: trying out this method on a forex demo account might be interesting, but can’t be trusted – the quotes in demo accounts sometimes lag – the gaps could be the result of this issue. You can see this work many times in demo account, but fail in a real account. I highly recommend a demo account for many purposes, but in case of this forex arbitrage, it just won’t work.
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