✔Let’s clear the concept of arbitrage with an easy example.
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💥EUR/JPY currency pair
Suppose a bank quoted EUR/JPY forex pair in London at 122.500. But the same pair was quoted by another bank in Tokyo at 122.540. The trader who has access to both the quotes will be able to buy it at London price and sell it at Tokyo price. During the market convergence, let’s say prices would be 122.550.
For that instance, the trader will have to close both the trades. In Tokyo, he will lose one pip, but in London, he would gain a profit of 5 pips. So, in the end, the trader would gain a transaction that costs less than 4 pips.
Forex arbitrage strategies are varied for enhancing the chances of profits. The traders look for price differences in various combinations of trading instruments. Some effective forex arbitrage strategies are given as follows.
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A change in negative spread strategies involving three or more foreign currencies due to discrepancies among them when exchange rates do not match is called triangular arbitrage.
A typical example of a triangular negative spread is EUR/USD, USD/JPY, and EUR/JPY.
💥Interest rate arbitrage
This arbitrage strategy is known as the carry trade. Traders sell the currencies with a lower interest rate and buy the currencies with higher interest rates. When the person reserves the currencies with a higher interest rate, he will profit from the interest rate difference.
The strategy includes the inherent risk of time, as, during a certain time period, traders can reverse their position, the rate of the currencies, and ever the interest rate as well.
This strategy involves occupying the positions for a particular currency in the spot and futures market. Forex traders use this strategy to short in the spot market and widen the long position for the future market.
Arbitraging arises opportunities in the forex markets by exploiting market discrepancies. When the number of players is increased, the profitability erodes. Therefore, one should have the fastest technological support and time-accurate market updates to gain profit by involving arbitrage.
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