To understand the Forex arbitrage system, it might be good to start by not even worrying about the Forex part.  Let’s just make sure we understand what arbitrage means, beyond the pronunciation: AHR-buh-trajzh.

Understanding Arbitrage

According to InvestorWords.com, arbitrage is “…attempting to profit by exploiting price differences of identical or similar financial instruments, on different markets or in different forms. The ideal version is riskless arbitrage.”

I know, I know – what?  Here’s a simpler way of saying that.  Arbitrage is a trading technique.  The trader tries to make a gain or profit, by finding price discrepancies when the same security, currency or commodity is traded on different markets.

Let me describe it in non-financial terms.  On Saturday you went shopping.  You saw a toaster at Wal-Mart for $12.  Then you went around the corner to Target.  There, you saw the same toaster (same brand, model, etc.) for only $11.  Wal-Mart’s policy is to have the lowest prices or they’ll pay you the difference.  To do the “arbitrage” you would buy the Target toaster and show your receipt to Wal-Mart. Wal-Mart pays you the difference.  At the better price, you’ll get the toaster plus $1!

Since Forex is all about trading currency, Forex arbitrage trading means making currency trades when you see different prices for the same currency on different markets.  Using the example above, you can see that if the Japanese yen (toaster) is going for one price in London (Wal-Mart) and a different price in Amsterdam (Target), a good trader will want to buy at the lower Amsterdam price and sell at the higher London price to make the best Forex investment!

Now that we understand basic Forex arbitrage, there are a couple of things to remember before we rush to start using it.

Is It Really “Riskless”?

Market trading is speculative, which means it is basically guesswork, even if done by an expert.  All speculation carries risk.  So before you enter any market, whether Forex currency trading or to trade stocks and commodities, be prepared to take the risk of losing the money you invest if your guess is wrong.