What Is Arbitrage?

Arbitrage takes advantage of market inefficiencies and exploits ꦆshort-lived variations in the price of identical or similar financial instruments in different markets or veh💜icles. 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开奖号码历史查询:forex pairs. These assets can often be transacted in multiple markets at onꦍce. This 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 mod🐻ern 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开奖号码历史查询: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开奖号码历史查询:financial instruments. Any inefficient p♛ricing setups are usu🏅ally acted upon quickly, and the opportunity is eliminated, often in a matter of seconds.

Examples of Arbitrage

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

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

The trader can continue to exploit this arbitrage until the specialists on the NYSE run out o📖f inventory of Company X’s stock, or until the specialists on the NYSE or the LSE adjust their prices to wꦐipe 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 t🦋rader converts one currency to another, converts that second currency to a third currency, and finally converts the⛦ third currency back 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.

With♌ these exchange rates, there is an arbitr꧅age 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 would receive an arbitrage 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-free𒐪 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 arbitꦯrage 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 bet𒉰ween different assets or securities.♓

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