Arbitrage

Reviewed by Bhavana | Updated on Aug 27, 2020

Introduction to Arbitrage

Arbitrage is the buying and selling of an asset at the same time to benefit from a difference in the price. It is a trade which benefits on different markets or in different forms by exploiting the price fluctuations of identical/similar financial instruments. Arbitration exists due to market inefficiencies, and therefore would not exist if all markets were perfectly efficient.

Strategy development can assist a trader in ensuring that he or she receives results regularly while staying away from behavioural finance biases. All of this is equally true for anyone who trades on the foreign exchange market. One technique, traders use, is called arbitrage in the market.

Basically, arbitrage is purchasing a security in one market and at the same time selling it at a greater price in another market; thereby, profiting from the temporary price gap. For an investor/trader, this is called a risk-free benefit.

An Important Note

If all economies were perfectly efficient, there would never be any arbitrage-related chances, but markets rarely remain flawless. Another factor which needs to be considered is transaction costs. We can transform a good arbitration situation into one that doesn't favour the investor.

Arbitration is considered a risk-free benefit for the seller. It provides a mechanism to ensure that rates over long periods of time do not greatly deviate from the fair value. Despite advances in technology, profiting from price mistakes on the market has become extremely difficult.