There are times when many investing experts mention that the market is being inefficient. With that term, they do not refer to the speed of trades, but to the price of stocks, bonds, currencies and other assets are not according to their value. During this period, investors usually keep gaining money through arbitrage.
Arbitrage is a process that requires a high volume, speed, as well as the complex knowledge of investing.
Ways that Arbitrage Works
This following example will make you understand arbitrage easily. Imagine that you are about to buy the shares of BBB company on the New York Stock Exchange (NYSE) at $40 per share.
At the same time, you know that the shares of the same company are trading at $40.25 at the Euronext Exchange. If you want to do arbitrage, then you buy that BBB shares on the NYSE and sell them directly on the Euronext.
That way you will gain 25 cents from each share. The number may not seem significant, but once you buy and sell 10,000 shares, you will gain $2500 from a single transaction.
Arbitrage in a Current Market
Arbitrage can only happen if there is a pricing discrepancy in two financial institutions. In the past days, these discrepancies are common. That made even the common average investors can use it since the information does not spread fast.
However, these days that discrepancies can end in a millisecond. Besides, the discrepancies we encounter these days usually are very small. Thus, if you do not have a sizeable amount to invest, you better reconsider your decision to do arbitrage.
Arbitrage, these days, usually are carried out by high-frequency traders. These are the people with complex algorithms and ultra fast computers and internet connection that scan the market in a extremely fast way.
That way these people can execute very high volumes orders quickly. Thus, competing with them can be super difficult.