The more frequent opportunities arise, the more it describes the uneven pricing of currencies patterns. The arbitrage strategy may cause an investor to be stuck with his work in foreign exchange and earn profits because of pricing inefficiencies. Basically, it is a scenario which is described by the issues of disequilibrium in the pricing strategies. Because of over or under pricing, some events are not in favor of traders. Investors usually try to take a backup tire to remain safe from contingent events.
Triangular arbitrage or three-point arbitrage is a widespread practice being implemented in the foreign exchange trading market. This is a systematic way towards triangular arbitrage. The process of triangular arbitrage is really ordered and even a small jumble can cause it to leave its boundaries of triangular arbitrage since it may be considered as a sensitive phenomenon.
The triangular arbitrage strategy involves the following steps:
1) Investing Currency A in to Currency B
2) Investing Currency B in to Currency C
3) Again investing the currency C back in to currency A
In this Figure, we can see one example where the investor has $1,000,000.
Currency A is USD
Currency B is CAD
Currency C is CHF.
Profit is : $1005,222
The list of benefits that any investor may earn through triangle arbitrage strategy is as follows:
1) Profits and returns on huge investments;
2) Risk is placed on the least level, however a small amount of risk is present in each of the investment transaction;
3) Invest to earn returns, no more problematic issues;
4) To earn profits, the strategy may be adopted in uncertain situations;
5) When market situations are said to be uncertain, it is recommended to make shorter term investment. This implies that investors may earn profits even when situations are declared as uncertain.
How can a common trader earn money using arbitrage strategy?
You don’t need to have a million dollars or to have accounts at several forex brokers. You can earn money using statistical arbitrage strategy when you are trading with micro and mini lots and by using only one forex account.
Arbitrage strategy or pairs trading or convergence trading is based on statistics and mean reversion. You need to find two historically correlated forex pairs using a currency correlation calculator. When the correlation between the two forex pairs diverges beyond a certain value or weakens, you need to buy the weakest forex pair and sell the strongest forex pair. When the mean reversion takes place, the number of pips of these two trades will be positive.
Step 1 : Find the currency correlation calculator at the two historically correlated forex pairs. Today, I will pick NZDJPY and EURJPY. In the last 10 days, the correlation was 94.5 (if the correlation is bigger than 90, then that is excellent).
Step 2 : Activate custom indicator.
Using the custom standard deviation indicator on daily chart, we can compare this two currency pairs. In the image above, we can see that the blue line spreads across; yellow line -1 standard deviation from moving average and white line moving average.
Step 3: Find entry and exit :
You can enter when the blue line crosses the yellow line (buy order). Or you can enter when the blue line crosses the red line (sell order). Exit when the spread reverts to the mean (moving average white line). Stop when the loss is as far as the target price. In this strategy, I used the 1:1 profit/loss ratio and I always use an Expert Advisor to generate sell and buy orders.
Set 4 : Results from October 2012 :
BUY EURJPY : +126 pips
SELL NZDJPY: -64 pips
Profit : 62 pips
In this strategy, if we try to use 15 min. charts or 5 min. charts forex broker spreads can affect our profit. On the other hand, forex pairs correlation can change very fast in 15 min. time frame. This is the best results I get when I use daily chart for statistical arbitrage trading.
If one currency is being devalued and the other is increasing in value then the investors can make extraordinary benefits by making investments in the foreign exchange. Nowadays, foreign exchange has become a profitable business but it needs expertise and knowledge of foreign exchange trading tricks and soft rules. The rules are known as soft rules because they are not hard and fast. They might change from one period of time to the other. It is also possible that you may get a positive experience by using one trick and the next time it may fail. Use statistics in forex trading and try to develop a strategy in order to adapt to any market condition.
If you decide to trade using statistical arbitrage please use the daily charts to avoid loss. Always use indicators and monitor the currency correlation.