Arbitrage is a popular strategy that allows traders to profit from price differences for the same asset on different exchanges. However, to benefit from arbitrage, traders need to know certain details about it and its core principles. Arbitrage can be used in Forex, stocks, and almost every asset class but cryptos are most popular for a good reason. Let’s overview the benefits of arbitrating and how to profit from it legally without getting your account suspended by the broker.
How arbitrage works
Arbitrage is a trading strategy employed by online financial traders. This strategy exploits temporary price differences between different markets for the same asset. Traders buy an asset where it is cheaper and sell it to the market where it is slightly expensive, making profits in the process. Arbitrage allows traders to profit from price discrepancies without taking excessive risks as it has higher chances of success when compared to traditional financial trading where traders need to gauge market sentiment and use statistics to make profits. Arbitrage can be employed in many different markets and ways. Most popular is crypto markets but Forex markets can also be exploited. FX arbitrage strategy uses similar concepts but traders now target currencies and price differences between currency pairs. If the GBP/USD rate difference is greater than EUR/USD, traders might try to buy cheap and sell expensive. However, it is difficult to find arbitrage opportunities in FX markets and cryptos are much more popular because of their inherent nature.
Crypto arbitrage explained
Cryptocurrencies are the most popular asset class for arbitrage trading as their decentralized nature means the same coin might be priced differently across different decentralized platforms, leaving room for price discrepancies to arise. Arbitrage is actually very beneficial for crypto exchanges as it ensures the prices are stabilized closer to each other across many platforms contributing to liquidity. For example: let’s suppose Ethereum is trading at 3,500 USD on Binance but 3,520 on Coinbase. A trader might buy 10 Eths on Binance for 35 grand and sell it on Coinbase for 35,200 dollars, earning a 200 USD profit (minus fees). There are hundreds of altcoins or crypto tokens traded on many exchanges and traders can use any of them for arbitrage whenever an opportunity presents itself.
Types of arbitrage
There are several types of arbitrage strategies employed by financial traders. Let’s briefly explain each of them.
Spatial arbitrage
Our example of Bitcoin arbitrage trading was actually spatial arbitrage, where a trader buys and sells the same asset on different exchanges. When an asset is cheap on one exchange, a trader might buy it to sell it on another exchange where it is more expensive. When done with sufficient volume, even tiny price differences can create substantial profit opportunities.
Statistical arbitrage
Statistical arbitrage traders use quantitative models and algorithms to find extremely short-term price inefficiencies. This method is used by hedge funds and institutional traders as these algorithms are not cheap to develop and are mostly accessible to investors with substantial capital under their management.
Triangular arbitrage
Triangular arbitrage can be used in FX markets where traders exploit price discrepancies between three currency pairs. For example, converting USD to EUr than GBP, and back to USD for a profit. FX arbitrage requires substantial trading volume to be feasible because of spreads and commissions. So, brokers with super-low spreads are preferable.Â
Futures arbitrage
Traders might also use the arbitrage method where they take advantage of price differences between the spot market and futures contracts. For example, buying gold in the spot market and selling it via futures. This is a complex method and only highly experienced traders should undertake futures arbitrage.
Risk arbitrage
This is when traders trade based on expected price movements during mergers and acquisitions. Traders might buy shares of a company being acquired before the deal is finalized.
How to Benefit from Arbitrage Trading
Arbitrage has lower risks when compared to traditional trading because it enables traders to profit from price differences. Crypto traders can use smart contracts to conduct the full arbitrage operation in one transaction, making it a very low-risk endeavor. It is smart to use leverage to maximize potential profits. Crypto traders often employ the crypto-only loan method, flash loans, where they can borrow money, conduct arbitrage operations, and give the borrowed money back all in one transaction.
To ensure you benefit from arbitrage trading, it is important to understand all the costs related to financial trading. Traders must use low-spread brokers with low trading commissions so as not to lose all profits to commissions. Since price differences are mostly tiny, only the lowest spread brokers will be useful to deploy your arbitrage strategy profitably.
Also Read: LeverageSix: Redefining Crypto Exchange with Altcoin Trading, Staking, and Arbitrage
