How has arbitrage trading made life easier for forex investors?
January 18, 2022 (Investorideas.com Newswire) Every trader who has tried himself in the Forex market is well aware of the rule that there is no high profitability without high risk. However, there are some exceptions to this rule. One of these exceptions is arbitrage trading strategies that allow you to get hundreds of percent of the profit with minimal risk. Let's figure out what arbitrage trading is and how it can be implemented in the Forex market.
Classic arbitrage is about making profit from the price difference from the same financial instruments traded on different exchanges. The essence of arbitrage trading is that when the price of an asset on one exchange platform goes up, the asset is simultaneously sold on the first one and bought on the second. When prices become the same again, the positions are closed and the trader receives a guaranteed profit.
Naturally, the difference in prices should exceed the costs (spread, commission) in both markets. The attractiveness of such arbitrage transactions lies in the guaranteed profit and low risks since the total position always remains neutral to the market. The risks are mostly of a technical nature.
Applying Strategies in Trading
Let's consider how you can take advantage of arbitrage Forex strategies while trading. Surely many investors have noticed that the quotes of different Forex brokers at different points in time may slightly differ. So, one of the options for implementing an arbitrage strategy in Forex is to find two brokers that have the greatest price discrepancy for the same currency pair and organize arbitrage trading between them. In this case, at times of price divergence, it will be necessary to open opposite deals with both brokers. This will be the implementation of the classic two-way arbitration.
However, in Forex, the so-called one-legged arbitrage is more profitable, which differs in that the transaction is concluded on the side of only one broker. The fact is that price discrepancies arise, as a rule, due to the fact that the broker's quotes at certain points in time begin to lag behind the real prices. Thus, if you have a leading source of quotes, for example, from another broker with a faster price flow, then at moments of price lag, you can open a position on the side of the lagging broker in the direction of the real price and get a guaranteed advantage. Naturally, in this case, it makes no sense to open a hedging deal on the side of the second broker.
Are There Drawbacks?
Of course, Forex arbitrage strategies have their drawbacks as well. First, you need to work hard to find a lagging broker and a leading source. Secondly, forex brokers do not welcome this way of making money, so you need to be very careful in implementing this strategy so as not to violate the trading regulations. However, in this case, the game is worth the candle, because, if successful, you can get hundreds of percent of the profit and more than compensate for all the costs.
How Do Traders Make Money with an Arbitrage Strategy?
When using an arbitrage strategy in the Forex market, you do not need to have a large deposit or open trading accounts with different brokers to make a profit. You can use a statistical arbitrage approach by trading micro or mini lots on the same trading account.
Statistical arbitrage, sometimes called pair trading, is based on reversion and statistics. You should, based on history, identify two currency pairs that have a high cross-correlation. When the correlation weakens, it is recommended to buy the weak pair and sell the strong pair. When the correlation recovers to normal, the difference in profit points will be positive and, accordingly, you will receive income. Let's consider the algorithm in practice:
- First step - Find two currency pairs that are highly correlated (use a correlation calculator). For example, try both NZD / JPY and EUR / JPY.
- Second step - We compare these currency pairs using a special indicator according to the following parameters: standard deviation, spread size and moving average line.
- Third step - you need to determine the moment of entering and exiting the market.
A buy trade can be opened when the blue line of the indicator crosses the yellow one, and when the blue line crosses the red one, we open a sell trade. Exit from a trading position occurs when the spread value is normalized and the line characterizing its value returns to the average value for the period. Also, trades should be closed when the level of losses exceeds the value, according to your money management.
In the arbitrage strategy, using 15 or 5-minute charts is preferable, while the size of the spread of a particular broker largely determines the level of profitability. However, one should not forget that the degree of correlation of currency pairs on a 15-minute chart can change too quickly. According to my observations, the best indicators of profitability can be obtained by trading on the daily chart. In many ways, arbitrage trading makes life easier for investors.
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