What is Arbitraging?
The word Arbitrage is derived from the French word arbitrer which means to ‘give judgement’.
One dictionary defines Arbitrage as ‘the simultaneous buying and selling of assets in different markets or in derivative forms, taking advantage of the differing prices.’ A second defines it as the trading of one currency for another in the hope of taking advantage of small differences in the currency conversion rates in order to achieve a profit. For example, if $1.00 buys £0.7, £1 buys 9.5 Euros and 1 Euro buys $0.16, then an arbitrage trader who starts with $1.00 earns: 1 x 0.7 x 9.5 x 0.16 = $1.064. This produces a profit of 6.4 cents or 6.4 percent. 6.4 cents doesn’t seem much but if, instead of trading $1, we trade $1,000,000, the profit would be $64,000!Â
From the above, it can be seen that Arbitraging isn’t about buying or selling anything. It’s about deciding whether the price of an item will increase or decrease in value and taking advantage of the price movement. A currency trader doesn’t buy or sell a currency with the intention of keeping it. The trader only buys a currency to sell it at a profit.