Arbitrage operations in stock market
Arbitrage is the simultaneous purchase and sale of an asset to profit from a difference in the price. It is a trade that profits by exploiting the price differences of identical or similar financial instruments on different markets or in different forms. Arbitrage exists as a result of market inefficiencies. Arbitrage provides a mechanism to ensure prices do not deviate substantially from fair value for long periods of time.
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With advancements in technology, it has become extremely difficult to profit from pricing errors in the market. Many traders have computerized trading systems set to monitor fluctuations in similar financial instruments.
Market Arbitrage
Any inefficient pricing setups are usually acted upon quickly, and the opportunity is often eliminated in a matter of seconds. Arbitrage is a necessary force in the financial marketplace.
To understand more of this concept, read Trading The Odds With Arbitrage. As a simple example of arbitrage, consider the following.
Exploiting arbitrage opportunities: From trading stocks to sports. — Trademate Sports
A trader can buy the stock on the NYSE and immediately sell the same shares on the LSE, earning a profit of 5 cents per share. The trader could continue to exploit this arbitrage until the specialists on the NYSE run out of inventory of Company X's stock, or until the specialists on the NYSE or LSE adjust their prices to wipe out the opportunity. Though this is not the most complicated arbitrage strategy in use, this example of triangular arbitrage is more difficult than the above example.
In triangular arbitrage, a trader converts one currency to another at one bank, converts that second currency to another at a second bank, and finally converts the third currency back to the original at a third bank. The same bank would have the information efficiency to ensure all of its currency rates were aligned, requiring the use of different financial institutions for this strategy.
You see that at three different institutions the following currency exchange rates are immediately available:. Next, you would take the 1,, euros and convert them to pounds at the 1. Next, you would take the pounds and convert them back to U. Dictionary Term Of The Day. A measure of what it costs an investment company to operate a mutual fund.
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