What is Arbitrage Trading - Definition & Explanation

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It can also be defined as the practice of buying an asset and immediately selling it at a higher price on another exchange.

According to savvy investors, arbitrage is the practice of taking advantage of market inefficiencies to make a profit.

As a potentially lucrative financial strategy, arbitrage is used to make profits based on small market differences. In this way, experienced and fast-moving investors can seize the opportunity and make low-risk profits.

What you should know is that this concept exploits identical or similar financial instruments in different markets.

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What are the types of arbitrage trading?

1. triangular arbitrage

This refers to a discrepancy between three foreign currencies that occurs when the exchange rate of the currency does not produce a similar result. It is also a risk-free profit that occurs immediately when a quoted exchange rate does not match the market exchange rate.

As a strategy, it exploits the inefficiency of the market where one is overvalued and the other is undervalued. It is common knowledge that price differences in Exness are only a fraction of a cent. To make triangular arbitrage profitable, investors must trade with a large amount of capital.

2. fixed income securities

This is a trading strategy that takes advantage of arbitrage opportunities in interest rate securities. When an investor uses the fixed income arbitrage strategy, he takes opposite positions to take advantage of small price differences.

This is done while limiting interest rate risk. The concept is primarily used by hedge funds and investment firms. This strategy is also used by investors in swap spread arbitrage, where investors take opposite long and short positions in a swap and a Treasury bond.

What you should know is that in some cases this strategy brings minimal returns and huge losses.

3. statistical arbitrage

This refers to a profit situation that results from price inefficiencies between assets. The concept is usually determined by mathematical modeling.

4. currency arbitrage

This refers to a foreign exchange strategy where a trader takes advantage of different spreads provided by brokers for selected currency pairs. It is important to note that different spreads on a currency pair mean differences between bid and ask rates.

Convertible arbitrage

This is where investors pursue a long strategy when it comes to convertible securities and a short position when it comes to common stocks. The strategy is used to capitalize on price inefficiencies that occur between stocks and convertible securities. This strategy is favored by large trading firms and hedge funds.