Definition – What does Arbitrage Strategy mean?
An arbitrage strategy is a trading strategy that attempts to exploit small price differences between related currency pairs or currency trading instruments. Done properly, a forex arbitrage strategy allows a trader to make a risk-free profit off of market pricing inefficiencies. An arbitrage strategy in currency trading essentially cancels out the risk of exposure to a particular currency and profits purely from market transactions.
ForexTerms explains Arbitrage Strategy
Forex arbitrage strategies are quickly becoming a thing of the past in that they are very difficult for an individual trader to pull off successfully. Simply put, a forex arbitrage strategy would follow the quotes of three (or more) related currency pairs – for example, USD/JPY, EUR/JPY and EUR/USD – and try to capture any price differences between the value of the yen as quoted against the euro compared to the dollar.
The euro and dollar exposure would then be cancelled out using the third pair. The profit involved would be small (think 1% or less), but the risk is essentially zero. That said, investment banks and hedge funds now have extremely powerful algorithms and computers carrying out arbitrage strategies as part of their proprietary trading. The odds of an individual trader being able to move faster than these systems or purchase a similar system are extremely low.