## What is 'Triangular Arbitrage'

Triangular arbitrage is the result of a discrepancy between three foreign currencies that occurs when the currency's exchange rates do not exactly match up. These opportunities are rare and traders who take advantage of them usually have advanced computer equipment and/or programs to automate the process. The trader would exchange an amount at one rate (EUR/USD), convert it again (EUR/GBP) and then covert it finally back to the original (USD/GBP), and assuming low transaction costs, net a profit.

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## BREAKING DOWN 'Triangular Arbitrage'

This type of arbitrage is a riskless profit that occurs when a quoted exchange rate does not equal the market's cross-exchange rate. It exploits an inefficiency in the market where one market is overvalued and another is undervalued. Price differences between exchange rates are only fractions of a cent, and in order for this form of arbitrage to be profitable, a trader must trade a large amount of capital.

## Example of Triangular Arbitrage

As an example, suppose you have \$1 million and you are provided with the following exchange rates: EUR/USD = 0.8631, EUR/GBP = 1.4600 and USD/GBP = 1.6939.

With these exchange rates there is an arbitrage opportunity:

Step 1. Sell dollars for euros: \$1 million x 0.8631 = €863,100

Step 2. Sell euros for pounds: €863,100/1.4600 = £591,164.40

Step 3. Sell pounds for dollars: £591,164.40 x 1.6939 = \$1,001,373

Step 4. Subtract the initial investment from the final amount: \$1,001,373 - \$1,000,000 = \$1,373

From these transactions, you would receive an arbitrage profit of \$1,373 (assuming no transaction costs or taxes).

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