An Introduction to the Triangular Arbitrage and the Forex Markets.
Arbitrage is a method of profiting from price or rate discrepancies when the same or similar assets are being traded in different markets or in different forms.
Photo by Shubham Dhage on Unsplash
Triangular arbitrage is a more complicated form of arbitrage in which, not one, but three assets are been traded in order to profit from price discrepancies.
In Wikipedia, one can find the following image. In it, is being detected a complete turnaround of a triangular arbitrage trade.
The starting point is $5'000'000, which would be used to buy Euros at a 0.8171 exchange rate. The initial dollar amount is now converted into €4'085'500, and this would be also used to buy British pounds at a 1.1910 rate. Finally, the £3'430'311 would be used to buy back dollars at a 1.4650 rate, which would result in $5'025'406, thus providing a $25'406 profit, a 0.50% return with a seemingly zero risk.
The above method can be tested as follows:
Let’s assume that the exchange rates for the following currency pairs are :
EUR/USD: 1.12
USD/GBP: 0.77
EUR/GBP: 0.87
By multiplying the EUR/USD rate by the USD/GBP rate we get a 0.8624 rate. This shows us that when converting EUR to USD and then to GBP would provide us with a better rate than if we would convert directly EUR to GBP at a 0.87 conversion rate.
If then the currency pair EUR/GBP is bought, the currency pair EUR/USD is sold, and finally, the USD/GBP currency pair is also sold, this would result in a zero-risk profit.
Sources
Triangular arbitrage (Wiki)
Triangular Arbitrage: Definition and Example
DISCLAIMER:
You must be aware of the risks and be willing to accept them in order to invest in these markets. Don’t trade with money you can’t afford to lose. The information contained in this article is for educational purposes only and is not to be a recommendation for any specific investment. Trading any market carries a high level of risk, and may not be suitable for all investors.
$Canadian Dollar - Jun 2023(CAD2306)$ $Australian Dollar - Jun 2023(AUD2306)$
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