Distinguish between currency trading and currency arbitrage
Answers
Explanation:
A currency arbitrage is 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 the miss priced rates.
Understanding 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.
The most important risk that forex traders must deal with while arbitraging currencies is execution risk. This risk refers to the possibility that the desired currency quote may be lost due to the fast-moving nature of forex markets.
KEY TAKEAWAYS
Currency arbitrage is the exploitation of differences in quotes offered by brokers.
Currency arbitrage can be practiced using different strategies, such as two-currency arbitrage and three-currency arbitrages.
Example of Currency Arbitrage
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 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.
Answer:
Currency trading, often referred to as foreign exchange or Forex, is the purchasing and selling of currencies in the foreign exchange marketplace, done with the objective of making profits. It is referred to as 'speculative Forex trading.' Forex trading is the largest market in the world, with nearly $2 trillion traded on a daily basis, with quick growth projections. The main factor that differentiates currency trading from other types of trading is its liquidity.
First and foremost we need to understand this concept before trying to use it to boost our returns. As the name in itself signifies, arbitrage means a process where there are simultaneous buying and selling of the asset in a way that the trader profits from the price difference between the two products. An arbitrage trade is a direct fallout of the market inefficiencies and it facilitates a mechanism that ensures that prices stay close to their fair value for maximum times and chances of any significant divergence narrow down significantly.