Arbitrage for Retail Forex Traders (2024)

Arbitrage is apractice ofearning money bysimultaneously buying andselling thesame asset ondifferent markets without exposing yourself totheasset value risk. Thesimplest example ofFX arbitrage would be tobuy acurrency atone broker atanAsk price that is lower than theBid price you can sell it atanother broker. There are four basic types ofarbitrage inForex:

• Plain currency pair arbitrage between two brokers.
• Arbitrage atone broker involving three or more currency pairs.
• Interest rate arbitrage with aswap-free broker andanormal broker.
• Triangular (ormore complex) swap arbitrage atone broker.

Despite their similarity, all these methods are quite different andhave distinct advantages anddisadvantages.

Currency pair arbitrage with two brokers

Consider this example: thequotes forEUR/USD read 1.0924/1.0925 ataBroker Aand1.0927/1.0928 atBroker B. Obviously, buying EUR/USD atBroker Afor1.0925 andselling it for1.0927 atBroker B looks like ano-brainer— you get 2 pips risk-free! However, forthese pips tobecome your profit, you have toclose your trades atboth Broker AandBroker B when thequotes equalize between thetwo brokers. Forexample, when Broker B's rate goes down to1.0924/1.0925, you can now close your Sell with Broker B for2 pips profit. If Broker A's rate remains thesame, you can close your Buy, losing only 1 pip (due tothespread). Your total profit forthis arbitrage operation:

2 pips (gain atBroker B)— 1 pip (spread atBroker A) = 1 pip

Advantages

• Simplicity— easy tounderstand andtocalculate.
• Lack ofasset value risks— once theright opportunity is detected andthetrades are executed, you do not depend oncurrency rates asthecombined position is market-neutral with zero exposure.

Disadvantages

• Theopportunities are rare— thedifference inquotes should be sufficiently big tocover thespread andtoprovide profit.
• You need tohave enough margin intwo trading accounts toexecute thedeals.
• You need some technical means ofexecuting both trades simultaneously attwo different brokers. It also has tobe done two times per one arbitrage operation— forentry andforexit.
• Execution risk is very high due totheabove-mentioned factors.
• Transaction costs fortransferring funds from a"winning" account toa"losing" account can destroy all theprofit.

Arbitrage atone broker with 3+ currency pairs

Consider thefollowing example: GBP/USD is trading at1.2918/1.2919, EUR/USD at1.0908/1.0909, andEUR/GBP at0.8448/0.8449.

You buy EUR/USD at1.0909 andsell GBP/USD at1.2918. What you get is thelocked position, which equals aEUR/GBP Buy at0.8448 (EUR/USD Ask divided byGBP/USD Bid).

If you simultaneously sell EUR/GBP at0.8448, you lock 3.2 pips ofprofit when therates normalize.

While 3.2 pips might sound quite cool, theproblem is that you have todeduct 3 pips ofspreads forclosing these three positions if you want torealize your profit. That leaves you with 0.2 pips profit, which is still quite good considering its "risk-free" nature.

What is important toremember here is that you have touse properly calculated position sizes insuch triangular arbitrage. Intheexample above, if you sell 1 lot ofGBP/USD, you need tobuy 1.1842 lots ofEUR/USD andsell 1.1842 lots ofEUR/GBP (calculated asGBP/USD Bid divided byEUR/USD Ask).

Advantages

• If everything is executed properly, there will be no exposure tocurrency risks.
• All money is atone broker— there is no need totransfer cash from thebroker where you "win" tothebroker where you "lose", unlike in thecase of theprevious arbitrage technique.

Disadvantages

• Extremely rare opportunities— brokers are not stupid andcheck their quotes thoroughly. They also might have clauses intheir Terms andConditions prohibiting such arbitrage methods. Still, you might be able tofind ECN brokers that would not mind this strategy.
• Involves paying spreads forthree positions, which is always costly, andmeans that theopportunities are next tononexistent.
• Position sizing calculation is not only difficult but affects theend results asnot many brokers let you use precise trade volumes down toaunit. If you are trading onMT4 orMT5, using acent account is essential toreach thenecessary precision.
• Execution risk, although lower than when you have touse different brokers, is still here. Getting arequote orslippage with atriangular arbitrage trade can be deadly.
• Triple margin— you will not get reduced margin requirements due tohedged positions because they are hedged indirectly, so you would need tokeep quite alot ofmoney topull such trades.

Arbitrage between aswap-free andanormal broker

If you are asavvy trader andare up-to-date with thecurrent central bank interest rates andtheir effect onForex trading, you have probably already thought: "Why not buy TRY/JPY ataswap-paying broker andsell it ataswap-free broker?" After all, there is arather large subset ofbrokers that offer Islamic accounts andneither charge nor pay overnight interest there.

Consider anexample: asofMay 8, 2021, you can buy 1 lot ofTRY/JPY atone broker andget 0.27 pip daily swap (which is about $2.45) andsimultaneously sell TRY/JPY ataswap-free broker. Any upward movement ofthecurrency pair will be compensated bytheopposite movement ofthesame size atanother broker, so theasset value risk seems mitigated. Your account attheswap-paying broker will be constantly accumulating positive interest rate difference between theTurkish lira andtheJapanese yen.

Advantages

• Opportunities are very easy tofind— there are many currency pairs with high positive swaps andthere is abundance ofswap-free brokers.
• No need forany sophisticated execution technology— theswaps arbitrage trades can be found andexecuted manually.

Disadvantages

• TheBid/Ask spread is thebiggest disadvantage ofthis arbitrage method. First, thespread forcurrency pairs (exotic ones) that offer such huge swaps are usually very wide. Second, you have torecover both spreads— foryour Buy andyour Sell— tostart earning money. Intheexample above, if thespread is 40 pips (which can be considered normal forTRY/JPY) ateach broker, you will spend 149 days just waiting fortherollover rates difference tocompensate thespreads.
• While currency rate risk seems removed here (same aswith thefirst type ofarbitrage), therate movements can be very strong with thekind ofcurrency pairs involved inthis. Keeping enough margin toprevent stop-out might prove difficult.
• Brokers hate this. Not thenormal swap-paying ones but theothers— swap-free ones. If they find out that you are arbitraging interest rate using their no-interest accounts, you might get your account blocked oryour profit removed. Unfortunately, such brokers are often unregulated andcan do almost anything they want with your account.
• Transaction costs (deposit/withdrawal fees) tokeep funds properly distributed between two brokers can be prohibitive.

Triangular swap arbitrage atasingle broker

Similar tothetriangular price arbitrage, its swap counterpart can be performed within confines ofasingle Forex broker. This significantly reduces theexecution risks, free margin requirements, andtransaction costs. Atthesame time, unlike it is thecase with theprice arbitrage, theswap arbitrage is not viewed so adversely bybrokers themselves.

Theconcept oftriangular arbitrage inForex has been popularized byMichal Kreslik andBogdan Caramalac— they both have developed thebasic tools forfinding andexecuting triangular (oreven quadrangular) swap arbitrage trades. Theexample ofsuch atrade is described below.

Let's assume that thebroker has thefollowing swaps onthree currency pairs:

• AUD/USD: +2.5 AUD forbuying, −8 AUD forselling;
• USD/JPY: +0.6 USD forbuying, −1.5 USD forselling;
• AUD/JPY: −0.5 AUD forbuying, −3.0 AUD forselling.

Therates are currently quoted as:

• AUD/USD— 0.7422/0.7423;
• USD/JPY— 112.47/112.48;
• AUD/JPY— 83.48/83.49.

You buy 1 lot ofAUD/USD and0.7423 lots ofUSD/JPY. You are now exposed toalong position inAUD/JPY with thesize of1 lot. You need tohedge it byselling 1 lot ofAUD/JPY. Now, you are inatriangular hedge lock, which should mitigate all thecurrency value risks.

From theswaps' perspective, you will be getting $1.85 ($A2.50 × 0.7422) foryour AUD/USD Buy and$0.44 ($0.60 × 0.7423) foryour USD/JPY Buy per day. You will also be paying $2.23 ($A3.00 × 0.7423) per day foryour AUD/JPY Sell. Therefore, your total daily gain from this arbitrage setup is $0.06.

While it does not look much, it can be considered risk-free foraslong astheswaps do not change.

Advantages

• Low execution risk aseverything is done within one broker, andthecurrency rates do not matter much here (except forproper position sizing) while swaps rarely change inamatter ofseconds.
• Brokers do not care much about this sort ofarbitrage. Swap arbitrageurs pay good spreads andrarely see realized profit (see Disadvantages below).
• Long-term passive income incase ofasuccessful setup.
• No losses due totransfer/deposit/withdrawal fees— everything is executed atone Forex broker.

Disadvantages

• Spreads— you have torecover thevalue lost tospreads onthree trades toget tobreakeven. Intheabove example, thetotal loss due tothespreads is $25.49 ($10 forAUD/USD, $6.60 forUSD/JPY, and$8.89 forAUD/JPY). It would take 425 days just torecover thespread loss! Likely, theswaps would change during theperiod.
• Technical difficulties forcoding proper opportunity detection andexecution tools.
• Anarbitrageur would need tohold enough margin forthree (ormore) positions ashedged margin reductions do not apply toindirect position locking.

Conclusion

Four methods ofarbitraging theretail foreign exchange market have been described. Asyou can see, none ofthem is completely risk-free while all four seem rather viable. What can be said about all ofthem is that even if an opportunity is found andexecuted flawlessly, they require significant capital toprovide meaningful income. There is little point inarbitraging with a$100 account forsome 15% yearly ROI.

Thelist does not include all thepossible methods ofarbitrage incurrency trading. It omits asubset oftechniques provided bycombining spot FX with options, futures, orother trading instruments.

If you want totell us more about how you use arbitrage opportunities inForex, please feel free tojoin discussions on our forum.