What Is Arbitrage? An Easy to Understand Guide for Traders

March 20, 2020

What is Arbitrage?

Arbitrage is one of the strategies commonly used in the stock or asset market. It’s when you take advantage of different prices between markets to make a profit.

For example: if you buy USD using THB on website A, it might cost you  ฿30. Website B will buy your USD for ฿32. If you buy from A and sell to B, then you make a ฿2 profit. It might not sound like a lot, but if you traded a million-dollars, you would have already made a ฿2 million profit at this time.

You can arbitrage many assets. While Forex arbitrage is the most popular strategy, there’s no need to limit your opportunities to make a profit. The price difference between each market can happen for various reasons such as currency fluctuations in the US and Thailand  resulting in different prices for some assets. Or sometimes, there’s news that hasn’t reached another market affects the asset price in one market already.

Arbitrage

Arbitrage Strategy with digital assets Market

digital assets Arbitrage is unsurprisingly common. For example, in Thailand, there are more than one digital asset exchanges. Each platform can be offering different digital assets prices at a given time. In theory, the higher the liquidity in an exchange, the better the price should be since you will have more orders to match your buy/sell prices with. If you have assets in both platforms, you can buy BTC from platform A while selling at platform B to make a profit without even transferring your assets between providers. You can also buy from platform A and then transfer to platform B to sell (you should still make some profit, even with some transaction fees involved).

Another strategy to make digital assets arbitrage is a cross-border transaction. It’s not uncommon for digital assets in each country to be different. For example, the demand for Bitcoin in South Korea is very high, which means Bitcoin price is usually higher compared to other markets. Or in Hong Kong during political crises or protests, Bitcoin prices could be up to 2% higher than other countries. This means if you buy Bitcoin from cheaper markets like Thailand and sell it to Korea or Hong Kong at a higher price, you can already make a profit from this Bitcoin arbitrage.

How to Identify Arbitrage Trading Opportunities?

Arbitrage trading might sound simple in theory. You just need to buy an asset for cheaper and sell it for a higher price to make a profit. But in reality, such occasions do not pop up frequently. And when the opportunity happens, Smart Money or bit traders might act faster and seize that profit more quickly than anyone.

Importantly, to be able to profit from arbitrage trading, you will first need to calculate the opportunity. If you are trying to execute arbitrage trades between Zipmex and another exchange, you must perform a cost analysis. Calculate if you will lose money, make only a few cents, or create a worthwhile profit. Remember to take into account the amount of exchange fee, as well as the miner fee. Only after these fees are properly accounted for on both platforms can you understand your position. This process can take a long time and cost you the profit opportunity. Successful arbitrage needs experiences, speed, and precision. Let’s see some of the arbitrage strategies to help you make a profit today.

Simple Arbitrage

As the name suggests, it is the easiest to understand and execute in the real world. This technique is to buy on an exchange such as Zipmex, where the prices are low and sell on any other digital assets exchange where the cost of that particular asset is higher. The calculation is simple. You only have the value of the asset that you buy and transaction fees. You can avoid the transaction fee by having assets in both exchanges. If you have THB in platform A and BTC in platform B, it means you can buy Bitcoin in platform A and sell on B at the same time to make a profit without any cross-platform transaction. The simple arbitrage is the most popular kind of arbitrage.

Triangular Arbitrage

Usually, you might look at the arbitrage opportunity between 2 platforms or markets. There are often some hidden risks or fees that make your arbitrage less profitable than it should be. When it comes to currency or digital asset tradings, you can explore a better opportunity called Triangular Arbitrage.

Triangular Arbitrage requires more complicated calculations, which makes it less popular among traders. Institutional investors are the ones with enough resources to leverage this strategy, which usually turns to auto trading using computers to seize the arbitrage opportunity instead of humans.

The example of Triangular Arbitrage is, let’s say you have ฿1 million. The exchange rate is  BTC/THB = ฿200,000, BTC/USD = $6,800, and USD/THB = ฿30

You have the arbitrage opportunity to

  • Trade THB for BTC: ฿1 million = 1,000,000/200,000 = 5 BTC
  • Change BTC to USD: 5 BTC x 6,800 = $34,000 USD
  • Sell USD to THB = $34,000 USD x 30 = ฿1,020,000

You can see that we started with ฿1 Million investment but ended up with ฿1,020,000 or ฿20,000 profit. This example is a straightforward calculation, but you also need to consider other costs involved, such as trading fees or transaction fees.

Risks Involved in Arbitrage Trading

All investments and trades out there come with their own set of risks. Arbitrage trading is no exception.

Limited calculation time

Making a profit from arbitrage usually requires fast calculation in a limited time. A lot of traders panic and can’t calculate the cost, risk, and profit well.

Underestimation of costs

The cost of arbitrage is more than just transaction fees. If you need to deposit THB to platform A to buy Bitcoin, transfer to platform B, see Bitcoin to THB, and withdraw THB out. You might need to pay the deposit fee, trading fee, transaction fee, and withdrawal fee. Don’t forget to calculate in advance or have a plan. So when the opportunity happens, you can act fast to make a profit.

Uncertainty of the price

digital assets prices are extremely volatile. This means that the price keeps changing regardless of the exchange that it is being traded on. When you try to execute an arbitrage trade, there always exists a risk where someone else might take advantage of the opportunity. Hence, there is no way that you can be sure that arbitrage trading will result in profit.

Regulation

If you want to make cross-border trades, please be mindful of the difference between each jurisdiction. You have to study the related law, such as anti-money laundering and KYC regulations.

After all, although you know what Arbitrage is, using it in real life needs a lot more research and practice. Like any other investment, you need to research and learn as much as possible. Try to invest with an acceptable amount of money for your risk tolerance level. The more experiences you have, the better the arbitrage trader you will be. We highly suggest Zipmex as the place to buy digital assets. Our prices are competitively lower than many exchanges as we thrive on an economy of scale. We also provide instant deposit and small trading fees. We are officially licensed by the SEC and ready to open for digital asset trading soon! Follow us on Facebook or Twitter for our official launch promo!