What is Arbitrage Trading? Definition and Example

What is arbitrage trading?

Imagine that you have the possibility to buy and sell the very same asset in two different places. Why would you want to do so? Because of the difference in prices on them. Arbitrage traders call it spread. Basically, you find a spread in prices on the same asset on different trading centers and open a bidirectional trade: long the cheaper and short the more expensive one. The price tends to get back to some average point (because it is the same asset, and it should have the same price). The result in both trades is your profit.

But this isn’t the only way of arbitrage trading. Another one is about understanding the mechanisms of exchanges’ liquidity movements. It only works with stocks and is possible to undertake on pre-market and post-market. A trader needs to find the difference in price between assets before the main trading session starts. This way he gets both an advantage in time and liquidity because there are way lower trading volumes before and after trading sessions. With lower volumes comes greater volatility, and with volatility comes inefficiencies in prices. After the start of the trading sessions, the price of the asset tends to converge, and a trader fixes profits.

Another type of arbitrage is funding rate trading. You need to find the difference between funding rates on several exchanges (it is way easier to do with crypto exchanges than with other ones) and open a bidirectional trade with the same posture. One trade takes your money for funding, and the other one gives you the money. The difference between them is your profit. This is the less risky arbitrage strategy, but the profit is extremely small (fractions of a percent per day).

Arbitrage trading example

When you trade currency, arbitrage can be found between brokers that collect data from different market centers. To find such trade you need to have a special soft, or at least tons of attention and dedication because the difference in prices is small and other arbitrage traders eliminate it within minutes. On the stock market arbitrages are cleared out in a matter of seconds with help of high-frequency trading robots from hedge funds and other companies. The potential outcome for one trade is unusually small (0.3% per trade on the stock market is a decent result), but such trades have really low risk if you understand what you are doing.

Let me describe to you an example of such trade. You have found that the price for BTCUSD at FBS is $61 000, and at the Binance Exchange, it is $62 000. You buy Bitcoin in FBS and sell it in Binance. When the price aligns you close both trades and grab your profit.

Be careful though, the price may go in one direction. You need more confirmations of your suggestion to open a trade. Good luck!

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2023-05-09 • Updated

Frequently asked questions

How to start Forex trading with a broker?

The very first step is to choose a reputable Forex broker. You can join FBS, a legitimate online broker regulated by IFSC, CySEC, ASIC, and FSCA. Learn the essentials and watch videos about Forex from FBS market experts, test your skills on a Demo account, and enter the trading world with ease.
What is Forex trading?

Forex, also known as the foreign exchange market or FX market, is the world's most traded market, with a $5.1 trillion turnover per day. In simple words, Forex trading is the process of converting one country's currency into the currency of another country, aiming to make a profit from the changes in its value.
What is a trading account?

To start trading on Forex, you must open an account. The primary purpose of trading accounts is to make transactions (open and close orders) with various financial instruments. The trading account is similar to the bank one – you use it to store, deposit, and withdraw money. However, deposits and withdrawals are available only after you verify your account.
What trading account should I choose?

FBS offers various account types designed to meet your needs, including Cent, Micro, Standard, Zero Spread, ECN, and Crypto accounts with unique trading conditions. For newbies who have no trading experience, we recommend opening a Demo account first, and only after that a Micro or Cent account. For those who are not the first day in trading, we advise opening a Standard account – a classic one. For real professionals, we suggest a Zero Spread account or ECN account. Finally, for modern traders who prefer digital assets, there is a Crypto account.