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The three most common methods of Forex arbitrage

When it comes to price arbitrage, many usually think of a trading method that allows you to make an immediate profit without the trader having to take any risks. In general, however, any trade that is based on the use of price inefficiency with “immediate” profit but also the trade combined with other factors that help it achieve profit in time can be both understood in terms of arbitrage.

As we have already stated, arbitration does not always have to take the same form. In today's article, we have written for you 3 ways of arbitration, which we believe are very popular among traders.

Method 1 - multi-pair arbitrage trades

The first arbitrage method, which if successful results in the immediate profit, is the rapid realization of a multi-pair trade. It is precisely this method that benefits from the above-mentioned price inefficiency, which occurs when the market is not able to "balance" exchange rate differences to an optimal / equilibrium state quickly enough.
 

Currency Pair

Exchange rate

Buy

Sell

EUR/USD 1,20 12000 USD 10000 EUR
GBP/USD 1,00 12000 GBP 12000 USD
EUR/GBP 1,19 10084 EUR 12000 GBP

Chart n.1: Example of multi-pair trade


The table above shows a multi-pair arbitrage trade. The initial trade on EUR / USD currency pair first sold € 10,000 and purchased $ 12,000. Subsequently, the purchased $ 12000 was sold for £ 12000 and finally all the pounds were sold for € 10084. It should now be clear from the table that the last trade resulted in more € than was needed for the first purchase, thus fulfilling the arbitration.


Method 2 - Arbitrage of undervalued and overvalued markets

This method of arbitration is much more complicated than the previous type. It requires considerable market experience from traders, as it is based on the search for business opportunities that result from the relative undervaluation or overvaluation of one of the markets. This means that, in this case, it is rather fundamental than technical arbitration and as such it is based on important market reports, analyzes and predictions.

Example:

According to economic reports, there is a rumour that the British pound (GBP) is undervalued by approximately 10% compared to the Japanese yen (JPY).
 

Such information can be used in practice for "arbitrage", in which the GBP JPY is bought on the currency pair, because there is an assumption that the pound will strengthen and the price rate will rise.
 

Method 3 - Arbitrage of positive swaps

The last very common way of arbitrage is trading positive swaps. Probably every trader already knows well that when trading, you can come across positive and negative swaps, which are charged in case you hold a position overnight.

This type of arbitrage consists in the fact that at one moment a specific currency pair is traded, more precisely a purchase or sale in the direction of a positive swap, and at the same time a fiat currency is purchased in the same volume, for example in an exchange. The profit here is therefore the income from positive swaps, from which, in addition, all fees must be deducted.
 

Example:

  1. At exchange rate of 1.00000 on EURUSD trader will sell € 100,000 because this position results in a positive swap
  2. € 100,000 will be purchased in an exchange office as a fiat currency

Due to the fact that these are de facto opposite positions, the trader does not have to deal with exchange rate changes and only needs to make sure that there is no change in the calculation of swaps that result from trading with currency pairs.

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