What is Arbitrage? How is it done?
Arbitrage, as an economics term, is a trade made with the aim of making risk-free profits by taking advantage of the inequality between the prices of an asset in different markets. For example, buying a currency in a market where it is cheap and selling it in a market where it is expensive is an arbitrage transaction. In order to arbitrage, it is necessary to trade in two markets at the same time and act very quickly. Because price differences can disappear in a short time.
What are the benefits of arbitrage?
Arbitrage has benefits for both arbitrageurs and markets. Arbitrageurs earn profits without risk. Markets, on the other hand, become more efficient and harmonious thanks to arbitrage. Arbitrage creates a single price for the same asset in different markets. Thus, market efficiency increases.
How is arbitrage done?
In order to arbitrage, it is first necessary to determine whether there are price differences for the same asset in different markets. Special software can be used for this process. If there is a price differential, the arbitrageur buys the asset in the cheaper market and sells it in the expensive market. It must do this simultaneously. Otherwise, prices may change and the arbitrage opportunity may be lost.
What should be considered when arbitrage?
Some costs and risks should also be taken into account when making arbitrage. For example, the spread between the buy and sell prices, the commissions and interest to be paid can reduce arbitrage profits. In addition, the liquidity, market depth and volatility of the assets to be arbitraged are also important. It can be difficult to arbitrage in illiquid, low-depth and highly volatile markets. Finally, currency risk should also be taken into account if the assets to be arbitraged are in different countries or currencies.