What Does Arbitrage Mean
Foreign exchange arbitrage and foreign exchange operation between the banks, representing the purchase (sale) of currency with the subsequent perform a reverse transaction to make a profit due to the difference in the courses on different exchange markets (spatial arbitrage) or due to exchange rate fluctuations for a certain period (temporal arbitrage). Recently, the value of spatial currency arbitration for objective reasons is increasingly weakening. At the same time, the role of temporary currency arbitrage is increasing, especially in connection with the approval of floating exchange rates in the currency markets.
The main principle of currency arbitrage is to buy currency cheaper and sell it more expensive. Simple currency arbitrage is carried out with two currencies; multilateral, complex (compound) – with three or more currencies on the terms of “spot” or “forward.”
Depending on the task, distinguish currency arbitrage can be:
- speculative, aiming to benefit from the difference in exchange rates due to their fluctuations (for example, in the scheme of Euro-us dollar; dollar-Euro);
- conversion, aimed at the most profitable purchase of the necessary currency.
With the transition to floating exchange rates, temporary currency arbitrage, based on the mismatch of the terms of purchase and sale of a currency, became widespread. Temporary currency arbitrage contains an element of speculation because the dealer expects to make a profit as a result of changes in exchange rates.
What is statistical arbitrage
Arbitrage itself is a method of trading that involves opening a long position on one instrument and a short position on the second and at the same time. For statistical arbitrage, only those instruments are selected that have a certain relationship between them, called correlation.
This can be, for example, two grades of oil or two market indices, as for Forex, here correlate with each other currency pairs. Usually, the graphs of such tools are very similar to each other in direct or mirror images.
At the moment of their maximum deviation from the general trend, multidirectional transactions are concluded. So, in the Forex market, a typical example of correlated pairs is EURUSD and USDCHF. It is enough to open both their charts on the screen at the same time to make sure that the price movements are connected.
What is triangular arbitrage
The scheme of triangular arbitrage differs from the usual scheme in that it has three open positions instead of two simultaneously open positions. Hence the name by analogy with the three vertices of the triangle.
Any arbitrage strategy involves creating a closed loop of positions that support it in relative equilibrium. For example, opening multidirectional positions on the same financial instrument, but at the different brokers-an an example of classical arbitration. In this case, the arbitrageur (trader) can catch even a small but guaranteed profit, fully insuring himself from the loss. A triangular type of arbitrage can be used in the foreign exchange market, but it does not require opening positions with different brokers.
Buying on sale, the same financial instrument, like a plus on a minus, in mathematics, in the end, gives zero. And zero is nothing more than the desired equilibrium of a triangular contour.
It should be noted here that in contrast to classical arbitrage, in this case, the volume of open positions is not the same.