Experienced Forex traders have probably noticed that there is occasionally a slight discrepancy between the quotes for a given financial instrument displayed by different brokers. Apart from possible manipulation by brokers, this happens as a result of temporary delays in the supply of quotes, smoothing of quotes, etc. The objective of an arbitration operation is to take advantage of these discrepancies. The trader places a buy order with a broker that has a lower price and simultaneously places a sell order for the same value with a broker that shows a higher price. The trade is executed when the profit that can be made from the existing difference in quotes is greater than the expenses incurred in the trade (ie the margin and commission paid to both brokers). This operation is known as classic arbitration (two legs). The main advantage of classical arbitrage is the absence of risk and drawdowns. If one broker’s quotes always lag another broker’s quotes, it makes more sense to apply one-leg arbitrage, where trades are placed only with the lagging broker. The advantage that one leg arbitrage has over classic arbitrage is that it has a higher profit potential; The downside is that this strategy involves drawdowns.
If we study the reasons behind the trading situations that make Forex arbitrage possible, we will see that in most cases they are caused by a lag in one broker’s market quotes relative to the more timely quotes of another broker. . Delays occur for a number of reasons: the amount of time it takes for a quote to be transmitted from a liquidity provider through a broker’s server to your trading terminal can be longer for some brokers; As the quotes pass through the brokers, they may undergo changes like filtering, smoothing, etc. As a result, when a security goes through significant price movements, the quote for the security you see in your trading terminal lags behind the actual market quote provided by liquidity providers. If the gap between the two quotes is wide enough to cover your trading costs, you can place an order through the lagging broker, with the goal of capturing the difference between the lagging quote and the broker’s actual quote with a higher quote. quick. In that case, you will have a statistical advantage over other traders. If the advantage is used properly, it is possible to achieve stable growth in profitability.
It should be noted that, with one-legged arbitrage, it is completely unnecessary to cover your open position with the second (faster) runner as you would with the classic arbitrage strategy. There are two reasons for this: the profit will accrue to your laggard broker anyway, and hedging will result in higher trading fees in the form of spread and commission you will have to pay to the second broker. This type of arbitration without coverage is known as unilateral arbitration.
It should be apparent that the successful application of Forex arbitrage requires access to a source that provides quotes that do not lag. You can use a broker with a faster quote feed. A more reliable alternative involves using market quotes provided by a large bank or broker, eg LMAX or Saxobank.
The number of opportunities for arbitrage trading can vary widely from broker to broker, anywhere from dozens per day to just a couple per month. It depends on the degree to which a given broker’s quotes lag behind the actual market quotes.
We can conclude by dismantling a popular myth that is often expressed on the Internet. According to a firmly held opinion of some, there is no point in participating in arbitrage operations, because brokers will not transfer your arbitrage profits to you. They can do this because commercially available arbitrage advisors execute ultra-fast trades that are required to alert brokers to arbitrage activity. Also, almost all brokers require a minimum waiting time between buying and selling a position, usually not less than 1-3 minutes. The stipulation falls under the brokers’ terms, and brokers have the right to cancel all transactions that do not meet their trading terms. However, arbitrage trades do not have to be executed instantly. If you increase the timeout of your position, you should have no problems with your broker. Based on our own experience, if you wait at least 10 minutes before exiting your position, you will have no problem closing it.
Let me explain why arbitrage trading can remain profitable even when there is a lead time between buying and selling a position. You always have a small advantage when the quote is delayed and you place an arbitrage order. It is impossible to say where the price will go after the quotes gap disappears, but if the volume of your trades is large enough, then half of your trades, regardless of the subsequent price movement, will be profitable, while you you will lose money. in the other half. That way, when your trading volume is considerable, the gains and losses incurred during price movements after the spread disappears will offset each other, leaving you with a small advantage. When this advantage is cumulative, it will ensure stable growth in profitability. Essentially, the increase in the holding period between entering and exiting your position will lead to an increase in the spread on your profitability chart (which will be reflected in the increased withdrawal from the account, something to be aware of). when choosing the lot size), while the average profitability of your trades will remain unchanged. Keep in mind, however, that this is only true when you do a large number of trades, since you have the law of large numbers working for you.
The result is that Forex arbitrage strategies continue to be a useful and highly profitable way to invest your money.
