One-legged Forex arbitrage

Experienced Forex traders have probably noticed that sometimes there is a slight discrepancy between the quotes for a given financial instrument, which are displayed by different brokers. In addition to possible manipulation by brokers, this is due to temporary delays in the supply of quotations, smoothing quotations, etc. The point of arbitrage is to take advantage of these inconsistencies. A trader places a buy order with a broker that has a lower price, and at the same time places an order to sell the same security to a broker that shows a higher price. Trading is carried out when the profit that can be obtained from the existing difference in quotations exceeds the costs incurred in trading (ie spread and commission paid to both brokers). This operation is known as classic (two-stage) arbitration. The main advantage of classical arbitration is the absence of risks and setbacks. If the quotations of one dealer always lag behind the quotations of another dealer, it is more reasonable to apply arbitrage on one leg, in which trades are held only with the lagging broker. The advantage that one-time arbitration has over classic arbitration consists of greater profit potential; the disadvantage is that this strategy entails a drawdown.

If we examine the reasons for trading situations that make Forex arbitrage possible, we will see that in most cases they are caused by the lag of market quotations of one broker relative to the more timely tape of quotations of another broker. Delays occur for a number of reasons: the amount of time it takes to transfer quotes from a liquidity provider through a broker’s server to your trading terminal may be greater for some brokers; if quotes pass through brokers, they may be subject to changes such as filtering, smoothing, etc. As a result, when a security undergoes significant price changes, the security quote you see at your trading terminal lags behind the actual market quotation as provided by liquidity providers. If the gap between the two quotes is wide enough to cover trading costs, you can place an order through a lagging broker, trying to capture the difference between the lagging quote and the real broker’s quote with a faster quote. In this case, you will have a statistical advantage over other traders. With proper use of the benefits, a stable increase in profitability can be achieved.

It should be noted that in the case of simultaneous arbitration arbitration, it is not necessary to hedge your open position with a second (faster) broker, as in the use of the classic arbitration strategy. There are two reasons for this: your lagging broker will still make a profit, and hedging will result in higher trading fees in the form of spreads and commissions that you will have to pay to the other broker. This type of arbitrage without hedging is called one-legged arbitration.

It should be clear that the successful application of Forex arbitrage requires access to a source that will provide quotes that are not far behind. You can use a broker with a faster quote channel. A more reliable alternative involves using market quotes provided by a major bank or broker, such as LMAX or Saxobank.

The number of opportunities for arbitrage trading can vary greatly from broker to broker, from dozens a day to a couple a month. It depends on the extent to which the quotes of this broker lag behind the real market quotes.

We can conclude by destroying a popular myth that is common on the internet. According to the firm belief of some, it makes no sense to engage in arbitrage trading, because brokers will not give you arbitrage profits. They are able to do this because arbitrage consultants available in the market perform ultra-fast trades that are required to alert brokers about arbitrage activities. Moreover, almost all brokers today require a minimum waiting time between buying and selling a position, usually at least 1-3 minutes. The agreement is subject to the terms of the brokers, and the brokers have the right to cancel all transactions that do not meet their terms of trade. However, arbitration transactions should not be executed immediately. If you increase the retention time of your position, you should not experience any hassle with your broker. Based on our own experience, if you wait at least 10 minutes before leaving your position, you will have no problem closing it.

Let me explain why arbitrage trading can be profitable, even if there is a waiting period between buying and selling a position. You always have a small advantage if the quote is delayed and you place an arbitration order. It is impossible to say where the price will go next after the differential of quotations disappears, but if the volume of your transactions is large enough, then half of the transactions, regardless of the subsequent price movement, will be profitable and you will lose money. from the second half. So if your trading volume is large, the profits and losses incurred during subsequent price movements after the differential disappears will offset each other, leaving you with a slight advantage. If this advantage accumulates, you will ensure a steady increase in profitability. In essence, increasing the retention period between entering and exiting your position will increase the variance on your profitability chart (which will be reflected in increased account drawdown, which should be considered when choosing a lot size), while the average profitability of your trades will remain unchanged. However, keep in mind that this is only true if you make a large number of transactions, because the law of large numbers works for you.

The result is that Forex arbitrage strategies remain a useful and very profitable way to invest your money.