Are there any reasons why an arbitrage won't work?

In many cases if you see a price discrepancy in your quotes by the time you try to arbitrage it it simply vanishes as if it never existed. There are a few reasons for this. One is when the quoted price you're seeing is wrong or is simply untradeable. Another possible reason is a bid-offer spread that wasn't accounted for. And in some cases, it is simply because the model you are using is wrong, or there is some risk factor you haven't taken account of.

Is arbitrage good or bad?

As with most things in the universe of trading arbitrage is neither good, nor bad. It is simply a way to take profits from the markets. In some cases, you might even call it good since it maintains the efficient market by removing outliers. Others claim arbitrage is bad because it takes advantage of situations that shouldn't exist, or that may exist by mistake. At the end of the day traders are out there to make profits, and if they can do so by working with any imbalances that occur then that is simply part of the market process.

What are the different types of arbitrage?

Arbitrage involves taking advantage of discrepancies in market prices, but it also takes many different forms. There is risk arbitrage, which involves buying the stocks of companies involved in a merger or acquisition. There is retail arbitrage, which is the buying and selling of physical products like you might see on eBay or Amazon. There is convertible arbitrage which is buying a convertible security and then shorting the underlying stock. And there is statistical arbitrage which works through the use of complex mathematical formulas that trade the markets programmatically to take advantage of even small price discrepancies.

What is Arbitrage in Finance & How to Use it ?

What is Arbitrage?

At its most basic, arbitrage can be defined as the concurrent purchase and sale of similar assets in different markets in order to take advantage of price differentials. When a trader uses arbitrage, they are essentially buying a cheaper asset and selling it at a higher price in a different market, thereby taking a profit without any net cash flow. Theoretically, arbitrage requires no capital and involves no risk but, in reality, attempts at arbitrage will involve both risk and capital.

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How Arbitrage Opportunities Occur

The Efficient Markets Hypothesis in the economic theory suggests that financial markets, including all investors and other active participants, will process all the information available to them with regard to asset values, quickly and efficiently. This would allow for very little room for price action discrepancies to occur across various markets. In practice, however, markets are never 100% efficient all the time due to the prevalence of asymmetrical information between the buyers and sellers within the market. An example of this inefficiency is when a seller’s asking price for an asset is lower than a buyer’s bid price. This situation is known as a “negative spread”, and is one of the main reasons for the appearance of arbitrage opportunities.

What Is Currency Arbitrage?

Currency arbitrage occurs when financial traders use price discrepancies in the money markets to take a profit. For instance, interest rate arbitrage is a popular way to trade on arbitrage in the currency market, by selling currency from a country with low-interest rates and, at the same time, buying the currency of a country that pays high-interest rates. The net difference in the two interest rates is the trading profit. This method is also known as “Carry Trade” Another form of currency arbitrage that investors use is known as “cash and carry.” This involves taking positions on the same asset within both the spot market and futures market simultaneously.

In this strategy, an investor will buy a currency and will then short sell the same currency in the futures market. Here, the trader is taking advantage of different spreads offered by different brokers for a specific currency pair. The different spreads will create a difference in the bid and ask prices, enabling a trader to take advantage of the different rates. For example, if broker A is offering the USD/EUR pair at 4/3 dollars per euro and broker B is offering this pair at a rate of 5/4 dollars per euro, a trader can convert one euro into USD with broker A, and they will then convert the USD back to EUR with broker B, resulting in a profit.

Statistical Arbitrage

Statistical arbitrage is derived from a collection of quantitative algorithmic investment strategies. This strategy is aimed at exploiting relative price movements of thousands of financial instruments in different markets through technical analysis. The ultimate aim of statistical arbitrage is to generate higher than normal trading profits for larger investors. It is worth noting that statistical arbitrage does not lend itself to high-frequency trading. Instead, it is used for medium-frequency trading, with trading periods taking anywhere from a few hours to several days. In statistical arbitrage, a trader will open a long and short position simultaneously in order to take advantage of inefficient pricing in assets that are correlated. For example, if a trader thinks that Amazon is overvalued, and Facebook is undervalued, they will open a long position on Amazon and at the same time, a short position on Facebook. This is often referred to as pairs trading.

Triangular Arbitrage

Another variation on the trade of negative spread is triangular arbitrage. This strategy involves the trading of three or more currencies simultaneously, increasing the odds that market inefficiency will result in profit-taking opportunities. With triangular arbitrage, a trader tries to find situations where a currency is overvalued in relation to one currency and undervalued relative to another. For instance, a trader may analyse the USD/JPY, EUR/JPY and EUR/USD currency pairs. If the euro is overvalued relative to the US dollar but undervalued when compared to the yen, the trader could use US dollar to buy JPY, use the JPY to buy EUR and later convert the euros to USD at a profit.

Risk Arbitrage (Merger Arbitrage)

Risk arbitrage, also known as merger arbitrage, involves taking positions in companies involved in a merger or acquisition. It’s a strategy used primarily in equity markets and is based on the price gap between a target company’s current stock price and the acquisition price proposed by the acquiring firm.

How It Works

When a merger is announced, the target company’s stock typically trades below the offer price due to uncertainty about whether the deal will close. Arbitrageurs buy shares of the target company, aiming to profit if the deal goes through at the proposed terms.

For example:
If Company A announces it will acquire Company B for $50 per share, and Company B is currently trading at $47, arbitrageurs may buy shares of Company B. If the deal completes, they profit from the $3 difference. If the deal falls through, the share price could drop significantly, resulting in a loss.

Why It’s Risky

Unlike pure arbitrage, which often exploits risk-free pricing gaps, merger arbitrage involves event risk. Delays, regulatory rejection, or shareholder resistance can derail the transaction. This risk-return trade-off requires careful analysis of the deal structure, financial health of both companies, and regulatory environment.

Historical Example

One of the most publicised merger arbitrage scenarios involved AT&T’s attempted acquisition of T-Mobile in 2011. After the deal was announced, arbitrageurs moved quickly to buy T-Mobile’s stock. However, due to antitrust opposition from the U.S. Department of Justice, the deal was eventually blocked, leading to losses for many traders betting on its completion.

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Crypto Arbitrage

Cryptocurrency markets are uniquely suited for arbitrage strategies, thanks to their decentralised structure, fragmented liquidity, and price variations across global exchanges.

While traditional markets have largely closed the window on manual arbitrage, crypto markets still present retail traders with real opportunities if they can act quickly and manage execution risks.

Common Crypto Arbitrage Strategies

Spatial Arbitrage (Inter-Exchange Arbitrage):
This involves buying a cryptocurrency on one exchange where it’s priced lower and selling it on another where it’s priced higher. The difference often a few percentage points can be a profit if fees and transfer times are minimal.
Triangular Arbitrage:
Traders exploit pricing inefficiencies between three currency pairs on the same exchange. For instance, converting BTC to ETH, ETH to USDT, and then USDT back to BTC, if the combined cycle yields a net gain.
Statistical Arbitrage with Bots:
Advanced traders deploy algorithms to detect and capitalise on temporary pricing anomalies across multiple exchanges. These bots are particularly useful during high-volatility events, like major news releases or sudden volume surges.

Real-World Example

During periods of extreme volatility such as the 2021 crypto bull run Bitcoin often traded at higher prices on Asian exchanges compared to Western ones.

This difference, known as the “Kimchi Premium” in South Korea, enabled cross-border traders to profit by transferring and selling Bitcoin in markets with inflated prices.

Considerations and Challenges

While crypto arbitrage appears straightforward, traders must account for:

Transaction fees and withdrawal limits
Blockchain confirmation times, which may delay execution
Exchange risk, including platform reliability and regulation
KYC/AML compliance, especially when moving funds between jurisdictions

Inter-Exchange Arbitrage

Inter-exchange arbitrage refers to the practice of buying an asset on one exchange and simultaneously selling it on another where the price is slightly higher.

Although often associated with cryptocurrencies, this strategy also applies to traditional financial markets especially in commodities, indices, and Forex when liquidity imbalances or timing differences arise.

How It Works

The core of this strategy is exploiting price discrepancies between two or more trading venues. For example:

Gold futures might be priced differently on the COMEX and LME exchanges.
The same stock listed as an ADR in the U.S. and a local share overseas may trade at divergent prices due to FX rates, supply, or sentiment.

Traders monitor these spreads in real time and aim to capitalise on short-lived inefficiencies before markets correct them.

Example: Arbitraging Brent and WTI Crude

At times, the price spread between Brent and WTI crude oil can widen due to geopolitical tensions, supply chain issues, or regional demand.

Traders who can access both instruments may buy the cheaper one and sell the more expensive, expecting the prices to converge.

Key Considerations

Latency: Speed is critical. Algorithms or fast order routing systems are often used to ensure execution before prices align.
Fees and Slippage: Transaction costs, funding rates, and execution quality can significantly reduce profitability.
Capital Requirements: Traders may need to maintain funds across multiple platforms to execute both sides of the trade near-simultaneously.

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Comparison of Arbitrage Strategies

Strategy	Markets Used	Risk Level	Execution Complexity	Tools Needed	Typical Users
Triangular Arbitrage	Forex	Low	Moderate	Real-time rate feeds, fast execution tools	Advanced retail, institutional
Risk Arbitrage	Equities (M&A deals)	High	High	Fundamental research, news monitoring	Hedge funds, event traders
Crypto Arbitrage	Cryptocurrencies	Medium	Moderate to High	Multiple exchange accounts, bots optional	Retail, algorithmic traders
Inter-Exchange Arbitrage	Commodities, Forex, Crypto	Medium	High	Multi-platform access, latency-sensitive tools	Quant traders, prop firms

Summary Points:

Low-risk arbitrage (like triangular) requires precision and speed but carries fewer unknowns.
High-risk approaches (e.g. risk arbitrage) depend on external events and regulatory factors.
Crypto arbitrage remains the most accessible for individual traders but requires vigilance on fees and execution.

Real-World Arbitrage Examples

Arbitrage isn’t just a theoretical concept; it’s been used for decades by traders, institutions, and even hedge funds to exploit pricing inefficiencies across global markets. Here are a few notable examples that showcase how arbitrage works in practice:

Example 1: Triangular Arbitrage in Forex Markets

In the currency markets, triangular arbitrage occurs when discrepancies arise in the quoted exchange rates between three currencies.

Case: Suppose EUR/USD = 1.10, USD/GBP = 0.75, and EUR/GBP = 0.83. A trader could potentially convert EUR to USD, then USD to GBP, and finally GBP back to EUR capitalising on minor differences in the cross rates. With automated systems, these trades are executed in milliseconds before the inefficiency disappears.

Example 2: Commodity Arbitrage – Gold Futures

In 2020, during periods of high volatility, traders noticed brief pricing discrepancies between gold spot prices on the London Bullion Market and gold futures on the COMEX. These price gaps sometimes driven by shipment delays or liquidity constraints allowed institutional traders to arbitrage between physical and paper gold markets.

Example 3: Crypto Arbitrage Across Exchanges

During the Bitcoin bull run in 2021, BTC prices varied significantly between exchanges. For example, Bitcoin could be trading at $63,500 on Coinbase and $63,900 on Binance. Traders with accounts on both platforms could profit by buying on the cheaper exchange and selling on the more expensive one often using bots to automate the process.

Example 4: Geographical Arbitrage – Tesla Stock

Before Tesla’s stock was included in the S&P 500, its shares were traded at different prices across various stock exchanges (e.g., NASDAQ vs. Frankfurt). Traders with access to both markets took advantage of time-zone differences and temporary imbalances in supply and demand, buying low in one region and selling high in another.

Key Takeaway:

Arbitrage thrives in environments where markets aren’t perfectly efficient. While some of these opportunities last only moments, others like regional pricing differences can persist longer, particularly in emerging or fragmented markets.

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Arbitrage – FAQs

Are there any reasons why an arbitrage won’t work?
In many cases if you see a price discrepancy in your quotes by the time you try to arbitrage it it simply vanishes as if it never existed. There are a few reasons for this. One is when the quoted price you’re seeing is wrong or is simply untradeable. Another possible reason is a bid-offer spread that wasn’t accounted for. And in some cases, it is simply because the model you are using is wrong, or there is some risk factor you haven’t taken account of.
Is arbitrage good or bad?
As with most things in the universe of trading arbitrage is neither good, nor bad. It is simply a way to take profits from the markets. In some cases, you might even call it good since it maintains the efficient market by removing outliers. Others claim arbitrage is bad because it takes advantage of situations that shouldn’t exist, or that may exist by mistake. At the end of the day traders are out there to make profits, and if they can do so by working with any imbalances that occur then that is simply part of the market process.
What are the different types of arbitrage?
Arbitrage involves taking advantage of discrepancies in market prices, but it also takes many different forms. There is risk arbitrage, which involves buying the stocks of companies involved in a merger or acquisition. There is retail arbitrage, which is the buying and selling of physical products like you might see on eBay or Amazon. There is convertible arbitrage which is buying a convertible security and then shorting the underlying stock. And there is statistical arbitrage which works through the use of complex mathematical formulas that trade the markets programmatically to take advantage of even small price discrepancies.

Final Words

Arbitrage allows a trader to exploit price discrepancies in assets, but this requires speed and adequate algorithms. In the financial markets, prices usually correct themselves in a short time. As a result, you will need to act quickly in order to take advantage of these trading opportunities.

Ready to Act on Arbitrage?

Whether you’re intrigued by the precision of triangular arbitrage, the calculated risks of merger trades, or the fast-paced nature of crypto spreads arbitrage offers a toolkit for traders looking to enhance their strategy with logic, timing, and opportunity.

At AvaTrade, we equip you with: