Types of arbitration on Forex
Classical arbitration is the exploitation of quotation inefficiency. Such arbitration is justifiably called spatial, because its existence is a consequence of the non-zero distance between the sources of quotations.
This wording is equally relevant for grandparents in the market, as well as for the stock exchange and high-frequency trading. No matter how fast the communication channels, we are still unable to transmit information faster than the speed of light. This means that between two remote sites a non-zero delay will always exist, only the tools for trading such arbitration will change.
Biped arbitration. This usually means arbitration between two exchanges. The difference in prices between the two sites allows you to buy cheaper and sell more expensive the same instrument.
A classic example is the purchase and sale of EURUSD from two different dealers. We actually buy or sell EURUSD spread.
In equity theory, this position will be zero. But the real market is always in motion, and given the overhead (spread commission) and different sources of quotations, the equity of such a position will fluctuate at some distance below zero. That is, if you try to buy and sell EURUSD now, you are likely to see on account an instant minus in the size of a double spread.
The arbitration is called the situation when equity moves into a profitable zone. That is, it is possible to say, we earned without risk, at the same time having bought and sold the same instrument.
The formation of such arbitration is due to the true decentralization of the exchange. When there is no single place for aggregation of quotations, there may always be a situation where the buyer offers a higher price than the seller wants.
It is important to note that when trading such arbitration, the direction of course movement does not matter to us. By buying the first and selling another instrument, we earn from changing their spread (difference). That is, in fact, the tool can increase the price on both exchanges, but you will still stay in the plus if the price difference decreases.
You can exit items either when a certain profit is achieved or you can expand items when a reverse condition occurs. That is, when reverse arbitration is formed, buyers and sellers will switch places.
Spatial arbitration became very common at the dawn of Forex formation. The main reason for large discrepancies in quotations is the weak centralization of the market itself, the emergence of a large number of small market makers and the lack of qualitative aggregation.
Most often, the formation of such arbitration was due to a significant lag in the quotations of one of the dealers. Now that most of the processes are standardized and liquidity suppliers are combined into a single stream of quotations through large aggregators, it is almost unrealistic to find and trade such a discrepancy to a conventional trader.
One-legged arbitration. In fact, simultaneous opening of positions on different exchanges is not a prerequisite. If you have the opportunity to determine the "leading" market, it is enough to open a transaction on only one site to trade arbitration.
For example, we have determined that Broker A quotations are a few seconds behind Broker B. At the same time, the price of broker B is currently 10 points higher. In that case, we enter the purchase through broker A, having a clear idea of where the price will go. On the technical side, this is much easier, but the arbitration situations themselves appear much less frequently. Another downside is the lack of market neutrality, which imposes additional risks and goes beyond classical arbitration.
Synthetic arbitration. Let 's say you wanted to trade EURUSD spread. Thus, you can buy the "real" EURUSD by concocting it with a synthetic, selling EURGBP and GBPUSD. If you remove the names of the instruments, you are unlikely to ever distinguish the synthetic EURUSD from its actual collection. However, the existing differences in quotations may be sufficient to form an arbitration, the trade of which is already a matter of technology.
Long-term arbitration. However, if you are satisfied with a small yield, there is quite a working ability to trade arbitration over a long period of time. It is, of course, a difference between the price of the futures and the underlying instrument at its core. In general, the strategy is similar to two-legged arbitration - when the spread between the two instruments increases, we buy their spread and wait for the expropriation.