How to use an Arbitrage strategy in Forex Trading
Introduction
Trading strategies are developed to get a definite edge in terms of risk/reward and winning probability. Over time tons of investors have laid out hundreds of game plans that differ in execution methods, monthly gains, drawdown, and complexity. While most fail in delivering results, some have stood the test of time by performing during market crashes and periods of great recessions. Arbitrage strategy is one leading game plan that capitalizes on price quotes amongst brokers for the same instrument.
Types of arbitrage strategy
The following types of arbitrage strategies are common amongst traders.
Two-way arbitrage
This strategy involves buying a currency from a brokerage and then selling it to another for a reasonable price. To understand better, consider an example where a trader finds an arbitrage opportunity on EUR/USD at which the price on one, let us say A, is 1.10200, and the other, B, is 1.10000. The investor takes advantage of the two pip difference by buying ten lots from A and selling it to B for a profit of $1818. Considering an average spread of 1 pip, the commission or transaction costs will be $200, which we can subtract to get $1618.
Generally, you won't find arbitrage opportunities with a large pip gap. The recent developments in the financial and technology infrastructure make up for any difference in the feed within milliseconds.
Three-way arbitrage
The primary approach for three-way arbitrage is similar in two ways. The difference lies in the use of transactions over three different exchanges rather than 2. Let us consider three pairs on 3 brokers, X, Y, and Z. The currencies USD/CHF, GBP/USD, and CHF/GBP are currently trading at 0.90000, 1.50000, and 1.20000, respectively. An arbitrageur buys one lot of the first pair at the designated price giving him 90,000 CHF. He then trades it for the British pound and gets 75,000 GBP. The trader finally exchanges the GBP in return for 112,500 USD, bagging a total profit of $12,500.
Interest arbitrage
Interest arbitrage involves investing in currencies that offer a better interest rate. To save yourself from the risk of currency depreciation, a trader uses a forward contract that locks in the exchange rate for a specific duration.
For example, consider an investor who finds out that the eurozone offers a better interest rate of 2% than 1% on the greenback. He takes out his million US dollars and converts it into euro at an exchange rate of 1.20000 through a forward contract of two years. At the end of the duration, he has tanked in a total profit of $20,000.
Can an arbitrage strategy alone provide consistent results?
Arbitrage strategy is generally considered as risk-free as it utilizes a 100% accurate leading indicator. There are some associated risks, however, that a trader should be careful of:
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Liquidity. There is a high chance of experiencing some slippage due to low liquidity. As we are looking to bargain a few pips here, even a small difference in the price can be detrimental to our arbitrage strategy.
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Execution. Slight issues with the connection can cause execution delays, which again is not beneficial. There is also a risk from the counterparty side if they fail to approve the incoming transaction.
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Capital requirement. The small pip changes demand that a trader trade needs bigger lots to profit from the position. Fast environments and better conditions are usually limited to traders working within big financial institutions.
Using algorithms to your advantage
Using the forex arbitrage strategy on manual terms is nearly impossible as the market algorithms are blazingly fast at balancing the currency prices. To solve the issue, traders have developed expert advisors who constantly scan the feed from various brokers within milliseconds. These robots can open and close hundreds of positions in a blink of an eye, while maintaining the appropriate risk management of your portfolio.
Steps to trade arbitrage
Within three simple steps, a trader can use the arbitrage trading forex strategy to his advantage.
Open an account with two or three different brokers as per your strategy. Verify your credentials if needed.
Deposit sufficient funds via available methods at your exchange.
Use appropriate live feeds or employ an fx arbitrage trading bot. Setup withdrawal methods and take out your cash often as it limits the risk to downside..
Before employing any strategy, it is always recommended to test it out on a demo portfolio before proceeding to go live.
About Forex Copier
Forex Copier is an automated software that helps you copy your trades on the same or different PCs. It has two versions:
Forex Copier remote 2 for copying trades remotely from one MetaTrader® platform to another.
Forex Copier 3 copies trade between MetaTrader® platforms on similar PCs.
The copy trading software has many valuable features, including lot/risk management, price adjustments, order filtering, tweaking SL/TP, and emergency stops to help you get an easy edge in the industry. It is possible to diversify your trading accounts and brokers by distributing your equity over several portfolios and using the auto trade copier to copy positions from one account to all of the others. You can also choose to sell subscriptions to your signals and EAs to investors worldwide, with or without access to their login credentials.
The scope here is unlimited, as the Forex Copier can help gurus in teaching by sharing their executions. For traders on a losing streak, the mirror trading software offers a reverse mode that turns all incoming buys into sales and vice versa with modifications of the exit and entry points.
