What Is Arbitrage Trading? A Guide for Beginners
As trading opportunities abound across markets, from stocks to crypto and everything in between by doing it right, you can actually turn a profit.
The only issue? Most traders lose money.
But they lose money because they haven't found a strategy that works for them. One of the best trading strategies is arbitrage.
What is arbitrage trading? It's one of the simplest trading strategies since it doesn't involve complex patterns or charts.
Wondering if this is the right strategy to jumpstart your trading journey? Read on below to find out now.
Trading Strategies Defined
There are many different ways you can make money in the markets.
Long-term traders will hold their positions for months, if not years, to take advantage of overarching trends. While the gratification is delayed, this type of trading can lead to the largest gains. It's more akin to investing in stocks rather than trading.
Medium-term traders, or swing traders, look to capitalize on trends or market patterns that unfold over days or weeks. And short-term traders, such as day traders or scalping traders, are looking to cash in on their days daily.
These traders rely on complex charting software, patterns, indicators, and lots of technical analysis. They are looking at previous price action and making educated guesses on the future price of a security.
And while it can be a lucrative strategy, it takes a long time to perfect.
But arbitrage trading is different. Rather than predicting an upcoming market shift, or trading based on previous performance, you are simply taking advantage of a discrepancy whenever it presents itself.
What Is Arbitrage Trading?
Arbitrage is a common term in the trading world, as well as in business. It's the process of buying an asset or commodity at one price from one marketplace and immediately selling it for a higher price at another marketplace.
Arbitrage opportunities appear all of the time because not every marketplace is in tune with one another. Each market operates independently.
While the price of assets almost always remains consistent, the price might be slower to update or react to a market shift on one marketplace compared to another. So the opportunities present themselves due to the inconsistencies of a free market.
If all marketplaces were perfectly in sync with one another, there would be no room for arbitrage.
Arbitrage Trading Examples
Here's an example of how arbitrage could work out in the stock market. Say you are looking at a particular stock, such as BP, the multinational petroleum company.
BP lists its stock on both the New York Stock Exchange (NYSE) and the London Stock Exchange. You can also find it on the big stock exchange in a handful of other countries.
Say that the current price of BP stocks were trading at $27.00 USD on the NYSE. But in London, BP is trading for $26.41 USD (after calculating the exchange rate).
The discrepancy is a temporary opportunity to buy on one exchange and sell on the other, to yield a profit of $0.59 USD per share.
After enough traders take advantage of this arbitrage opportunity, the price on each exchange will even out. And this happens very quickly, as many traders have programmed algorithms to spot these opportunities as soon as they arise.
Benefits of Arbitrage Trading
As a new trader, arbitrage is one of the best ways to invest in the stock market, or any other market, for short-term gains. Here are some reasons why you should start arbitraging.
A Risk-Free Trading Strategy
When it comes to arbitrage, you aren't guessing. You aren't making any predictions, so you aren't taking on the same level of risk that other types of traders are taking.
You are simply observing facts and trading based on those facts. An asset is listed for one price on one exchange and another price on a separate exchange.
Logic says that the difference in price can become profit in your pocket if you execute simultaneous buy and sell orders on each exchange.
No Trading Patterns or Indicators Required
Not ready to learn the ins and outs of technical analysis and stare at charts all day? With arbitrage trading, you don't need to memorize patterns and analyze past price history.
Simply scan the markets, look for inconsistencies, and take immediate action. When it comes to investing for beginners, it can't get any easier.
Arbitrage Trading Tips
Like anything in the financial markets, arbitrage trading is extremely competitive. If you see an opportunity to make a profitable trade, you need to take action right away before the spread disappears.
You also need to account for commissions. Depending on your broker, the commission you pay to buy or sell each share could neutralize any of the gains you are hoping to achieve. If your trading fees will be higher than the spread, then it's a losing trade.
Lastly, consider trading crypto when looking for arbitrage opportunities. Because cryptocurrency is a newer asset class, prices tend to deviate much more than stocks or forex. This creates more frequent arbitrage opportunities, especially as newer crypto exchanges come online all the time.
And since there are both centralized and decentralized exchanges, even more opportunities abound in the crypto markets. You can even use platforms like Crypto Hopper to help automate the process of finding and executing these trades.
Become a Profitable Trader
So what is arbitrage trading? It's one of the safest ways to get started as a trader, as traditional trading risks don't apply.
Are you hoping to become a profitable trader as fast as possible? If so, you can't do it alone. Trading is hard, and building a profitable strategy isn't always as simple as you might think.
Luckily, you can use a platform like Spiking to hasten the learning process by leveraging the experience of professional traders and getting inside tips on hot trading opportunities.
Sign up today to get access to our ultimate wealth management system, so you can go from a newbie to a profitable trader in no time.
Join the Spiking Wealth Community
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