Forex trading in Dubai is mainly about making profits through early anticipation of the movement direction of the price of a particular pair of currency. But what would you do if you get the opportunity to book profits without actually having to anticipate the forex prices? There are many trading strategies, which are market neutral, which still exist. One such low-risk forex trading strategy is forex arbitrage.
Arbitrage
Arbitrage is defined as a type of forex trading wherein the forex trader looks to make profits from the discrepancies in the price between the two very similar instruments. The forex traders who employ this type of forex trading in VPFX are called arbitrageurs.
An arbitrageur purchases in one forex market and sells an equivalent volume simultaneously in a separate and correlated forex market. They do so to take advantage of the cost divergence between the two forex markets.
Contrary to popular belief, arbitrage is a perfectly legal trading technique, which could help to improve the efficiency of the forex market. After all, once the forex trader identifies and exploits an opportunity for arbitrage, the market will begin to correct itself automatically.
Forex arbitrage
Forex arbitrage is essentially forex traders looking to do arbitrage in the forex market. In this practice, the forex trader aims to buy the cheaper variant of the currency, and at the same time, sell the more expensive variant of the currency. After the forex arbitrageur removes the transaction costs, the difference that remains is the profits that the trader gains between the two price indices.
The forex arbitrage system could operate in many different ways — however, the basics of forex trading always remain the same. A forex arbitrageur seeks to exploit the anomaly in the price of the currency to make profits. One method is to include the discrepancies between the currency futures and the spot rates. Here, a future is defined as an agreement or contract to trade a particular instrument on a selected date at a predetermined price.
Forex broker arbitrage will take place when two forex brokers in Malaysia quote different prices for the same pair of currency. But in a retail forex market, the price difference between two forex brokers usually remains uniform. It means that such a strategy is only limited to trading in institutional markets.
However, this strategy isn’t the only opportunity for forex arbitrage trading. There is a particular forex arbitrage trading strategy which involves observing three different pairs of currency. Let us look at the different types of trading strategies employed by forex arbitrageurs.
Trading strategy
The two trading strategies that arbitrageurs should know about are
- Forex triangular arbitrage
This method of forex arbitrage utilises offsetting trades in an attempt to make profits from the discrepancies in the currency prices in the forex exchange market. To understand and learn how to arbitrage forex currency pairs, the forex trader first needs to have a fundamental understanding of the pair of currency.
When the trader trades a particular pair of currency, they are effectively marking two trade positions — purchasing one forex currency from the pair while selling the other. The currency cross is a forex pair that doesn’t include the USD. A synthetic or theoretical value of the gross pair is implied with the rate of exchange of different currencies in the cross as against the US dollar.
Forex statistical arbitrage
Forex statistical arbitrage is not a type of arbitrage. It embarks on a quantitative strategy and seeks divergence in price that is more likely to statistically correct itself in the future.
Forex statistical arbitrage gets this done by compiling together a bunch of overperforming pairs of currencies as well as a separate bunch of underperforming pairs of currencies. These groups are created with a goal of short selling the overperforming pairs and buying more of underperforming pairs.
The relative assumption is that the value of one group will revert in relation to the other and will return to the mean value in the near future. With this type of assumption, one needs accurate historical correlation between these two groups. Therefore, this assumption is another aspect which the arbitrageur should take into consideration while compiling the groups of original currency pairs. While doing so, the forex trader should ensure market neutrality.
This is all the information you need about forex arbitrage and how to use it effectively in forex trading to make profits.
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