The trading industry is filled with so many sectors, and arbitrage trading is one of them. In the simplest of words, arbitrage is a strategy of taking advantage of price variances in various markets for the same assets. For this trade to be possible, there have to be at least two markets buying and selling a common commodity at different prices. In this trade, the trader profits from the unevenness of the asset prices in the markets. A simple example is buying an item from a cheaper market and selling it on another market where the price is a bit higher and bagging the difference.
Types of Arbitrage Trades
The following are the various types of arbitrage trading used in current markets worldwide;
This form of arbitrage is popular among hedge funds and is orchestrated during a merger of one company to another. Also known as merger arbitrage, this type consists of the buying of stocks in the process of a merger and acquisition. Here the trader buys the target’s stocks and short-sell the stocks of the acquirer.
This type of arbitrage is performed with typical everyday retail products we see in supermarkets and shops. One simply buys an item from a store at a lower price and sells it at a profit to another retailer at an added expense, keeping the extra. This type of arbitrage is more profitable if one does it on a larger scale as opposed to doing it on a one by one basis.
Convertible arbitrage involves the buying of a convertible security and short-selling its underlying stock to the highest bidder. Hedge funds also operate this investment strategy, and they capitalize on the price discrepancies between the convertible and the stock.
This type of arbitrage refers to the chance that is lost when the interest rate that a borrower pays on its depts is higher than the interest rate at which the same funds were bought using.
Statistical arbitrage is a trading technique that involves complicated mathematical models used to find trading openings among several financial instruments with differing market prices on their goods. The statistical models are typically based on mean-reverting methods, and they require a significant computation power. It is also known as StatArb.
Tips for using arbitrage trading
Do your research
Doing your background on an item before purchasing it must be done. This is because some prices might temporarily be different and get back to being the same, and you will be forced to sell at a loss. So much so, do your research and get to know if the commodity you would wish to trade is profitable in the long run.
After you have settled on stock, do your due diligence to stay updated. Regularly check the prices and strive always to be two steps ahead in case of anything.
Last but not least, if you have a question, ask. It will do you more good than harm, and you will learn more after. You have so much to gain and so little to lose, so why not.