Forex trading is popularly known as the attempt to profit from the prediction of the future direction of a market. But it goes more than that, and forex trading can employ numerous strategies that can still deliver profitability. One of the least risky strategies available is forex arbitrage.
During crises such as the current pandemic, the first to react are the financial markets. A good example is how the markets have turned during this COVID-19 situation. As the intensity of the situation increased, the markets have reacted with volatility, and in effect uncertainty.
Because of the pandemic, the whole world is deemed to potentially face the world’s worst recession since the Great Depression. The current situation has hit emerging markets currencies and the capital and economic growth projections also suggest further downtrend pressure. This trend means that the emerging markets forex likely remains the weakest link in the short term.
Surprisingly, some of the financial markets are still standing strong amidst the current situation. This might sound alarming, especially for forex traders who rely on future predictions, but luckily, there are strategies they can use to overcome the volatile markets.
How arbitrage plays a role in volatile forex markets
Arbitrage is the simultaneous buying and selling of assets such as forex in different exchanges, profiting from its price differential. This strategy is profitable even when markets are volatile because it does not rely on any economies. Arbitrage takes advantage of market inefficiencies and profits from them.
Some arbitrage trading strategies include two currencies, while others have three. “[It] is obvious that at least one of the currencies involved in FX arbitrage is sometimes mispriced to an extent that is sufficient to generate arbitrage opportunities,” according to a published study by Akram et al.
Because of the volatility of the forex markets through supply and demand, currency mispricing is evident due to constant changes in currency pairs across global markets. Some platforms can’t keep up with the changing figures of each currency fast enough, opening the way for mispricing through exchanges. Such occurrences are what we popularly know as market inefficiencies and arbitrage helps in alleviating these conditions.
Improving market inefficiencies through high-frequency trading
Even though the markets have evolved, the forex market still can be inefficient, especially during times of volatility. As the market trend rapidly changes, some exchanges globally aren’t able to capture price adjustments, thus, providing arbitrage opportunities. While some would only think that profitability is the only advantage of arbitrage, this strategy also helps equilibrate the markets.
“Arbitrage provides awareness to the markets that price discrepancies are present. Once the trade has been initiated, and an influx of either buying or selling of currencies arise in an exchange, a pricing gap may occur. Through this, exchanges turn cognizant of the mispricing, and as an answer, adjust it to the market price, bringing back efficiency to the markets,” explains Tony Jackson, Chief Executive Officer of Jubilee Ace, an automated arbitrage trading platform that offers forex arbitrage.
With the rise of technology and digital platforms, there’s a growth in high-frequency trading among markets. This strategy uses advanced technologies and dedicated algorithms to make trades for you automatically. As new arbitrage opportunities arise and fills quickly, the use of automation drastically helps execute arbitrage trading at speed.
According to a paper published by the European Central bank, “high-frequency tradings have a beneficial role in the price discovery process in terms of information being impounded into prices and smaller pricing errors.” Leveraging on price differentials are beneficial in the overall market standing.
“With high-frequency trading, anyone can increase their profitability and help make the markets efficient again. The benefits are for both traders and markets. It’s a win-win situation in all,” Jackson added.
Although the current pandemic has brought about different economic uncertainties, traders still have the option to grow their investment even during these times. Traders can employ alternative strategies and shy away from traditional methods to help weather the volatility of the markets. With arbitrage through high-frequency trading, you’re not only profiting, you’re equilibrating the markets.