Currency Arbitrage

AAA

DEFINITION of 'Currency Arbitrage'

A forex strategy in which a currency trader takes advantage of different spreads offered by brokers for a particular currency pair by making trades. Different spreads for a currency pair imply disparities between the bid and ask prices. Currency arbitrage involves buying and selling currency pairs from different brokers to take advantage of this disparity.


For example, two different banks (Bank A and Bank B) offer quotes for the US/EUR currency pair. Bank A sets the rate at 3/2 dollars per euro, and Bank B sets its rate at 4/3 dollars per euro. In currency arbitrage, the trader would take one euro, convert that into dollars with Bank A and then back into euros with Bank B. The end result is that the trader who started with one euro now has 9/8 euro. The trader has made a 1/8 euro profit if trading fees are not taken into account.

INVESTOPEDIA EXPLAINS 'Currency Arbitrage'

Currency arbitrage involves the exploitation of the differences in quotes rather than movements in the exchange rates of the currencies in the currency pair. Forex traders typically practice two-currency arbitrage, in which the differences between the spreads of two currencies are exploited. Traders can also practice three-currency arbitrage, also known as triangular arbitrage, which is a more complex strategy. Due to the use of computers and high-speed trading systems, large traders often catch differences in currency pair quotes and close the gap quickly.

RELATED TERMS
  1. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  2. Convertible Currency

    A currency that can be readily bought or sold without government ...
  3. Major Pairs

    The four forex pairs which are considered to be the most heavily ...
  4. Conversion Arbitrage

    An options trading strategy employed to exploit the inefficiencies ...
  5. Arbitrage

    The simultaneous purchase and sale of an asset in order to profit ...
  6. Forex - FX

    The market in which currencies are traded. The forex market is ...
RELATED FAQS
  1. How do I close a long position in forex?

    Closing a long position in forex trading depends on whether you are using a broker operating under U.S. trading regulations. In ... Read Full Answer >>
  2. Where did the term 'pip' in currency exchange come from?

    The term pip is an acronym for percentage in point or price interest point. It measures a unit of change within a pair of ... Read Full Answer >>
  3. How does a merger affect the shareholders?

    A merger affects the shareholders of both companies in different ways and is influenced by several factors, including the ... Read Full Answer >>
  4. How do I find positive correlation in the stock market?

    Positive correlation refers to a statistical relationship in which two variables generally move in the same direction together. ... Read Full Answer >>
  5. How do I implement a forex strategy when spotting a Upside Gap Two Crows Pattern?

    The upside gap two crows is, in theory, a bearish reversal pattern found in both the stock and forex markets. While there ... Read Full Answer >>
  6. What are the most common market indicators forex traders follow?

    There are literally hundreds of technical indicators for forex traders to choose from, however, there are a few which may ... Read Full Answer >>
Related Articles
  1. Options & Futures

    Arbitrage Squeezes Profit From Market Inefficiency

    This influential strategy capitalizes on the relationship between price and liquidity.
  2. Active Trading Fundamentals

    An Introduction To Day Trading

    This article will take an objective look at day trading, who does it and how it is done.
  3. Options & Futures

    Trading The Odds With Arbitrage

    Profiting from arbitrage is not only for market makers - retail traders can find opportunity in risk arbitrage.
  4. Forex Education

    A Primer On Cross Currency Triangulation

    This method to transact business in euros while making profits at home is essential. Find out how it's done.
  5. Mutual Funds & ETFs

    Invest in Emerging Market Currencies with this ETF

    Why this emerging market currency ETF needs to be on your radar.
  6. Forex Strategies

    An Introduction To Trading Forex Futures

    We explain what forex futures are, where they are traded, and the tools you need to successfully trade these derivatives.
  7. Chart Advisor

    Trade Europe and a Strong USD with this ETF

    With ETFs is't now possible to construct a portfolio of European equities and simultaneously hedge the currency risk.
  8. Trading Systems & Software

    Brokerage Reviews: TradeStation Vs. Interactive Brokers

    These are among the most sophisticated brokers in the industry in terms of investment offerings, market access and technology.
  9. Bonds & Fixed Income

    Understanding Negative Rates Of Europe's Central Banks

    We are currently seeing negative central bank deposit rates and government and corporate bonds with negative yields, but there are investors buying into these securities. Why?
  10. Trading Strategies

    Trade Forex Through Inside Day Breakout Strategy

    Inside day breakout is a popular strategy for forex trading. Here's how to recognize the patterns, entry/exit points and trading scenarios.

You May Also Like

Hot Definitions
  1. Expected Return

    The amount one would anticipate receiving on an investment that has various known or expected rates of return. For example, ...
  2. Carrying Value

    An accounting measure of value, where the value of an asset or a company is based on the figures in the company's balance ...
  3. Capital Account

    A national account that shows the net change in asset ownership for a nation. The capital account is the net result of public ...
  4. Brand Equity

    The value premium that a company realizes from a product with a recognizable name as compared to its generic equivalent. ...
  5. Adverse Selection

    1. The tendency of those in dangerous jobs or high risk lifestyles to get life insurance. 2. A situation where sellers have ...
Trading Center