In a nutshell, arbitrage is the purchase of a financial asset in one market and the sale of the same asset, executed quickly, in a different market: the gain is given by the fact that the purchase is made in a market where the asset is sold at a lower price and the sale on a market where the asset has a higher price.
Thus, profit is made from the simple price difference.
Arbitrage can be applied to many financial instruments: currency exchanges, financial stocks, commodities, and, in recent years, the exchange of cryptocurrencies.
To profit from arbitrage, and minimize risk, trades must be executed in the shortest possible time, comparing different platforms and markets to obtain the best selling and buying prices.
To do this, applications and websites have sprung up that execute everything automatically, such as https://arbisgap.com/.
If the mechanism of arbitrage is still unclear, let us try an example with cryptocurrencies.
Virtual currencies can be bought and resold online on various portals, but the list price is not fixed on all exchange sites, there may be some price differences.
The purpose of arbitrage, in this case, is to buy a coin on one website where it is presented at a lower price and then resell it on a second website where it is, instead, valued at a higher price.
Our gain, as you may have guessed, lies in the price difference.
Of course, not everything is so simple: websites often charge commissions for buying and selling, so our margin can be reduced by this commission.
Since the price differences on various exchanges are small, it is good to carefully assess and calculate how much the commission charged will eat into our profit.
Another element, already discussed above, is time: currencies change value constantly, so once you decide where to buy and where to sell, everything must be done as soon as possible.
Of course, a change in value could also be to our advantage, with the bought currency gaining value, but the risk is that if we don’t sell immediately, our cryptocurrency will depreciate.
As already mentioned, doing these transactions manually is very slow and risky, so it is always best to refer to modern online arbitrage software.
Another example of arbitrage can be done with the shares of an international company.
The shares might have a different value in two different countries, due to the simple difference in the value of the currency of the two countries.
By buying from the first country, at a lower cost, and reselling in another country, at a higher price, we will have executed an arbitrage transaction with a gain for our portfolio!
Beware, however, that this type of situation is usually short-lived: many people will be conducting similar arbitrage actions on those same equities, and this will take the two markets to have an identical value, rebalancing the situation, and effectively making arbitrage between the two parties impossible.
Such a situation must therefore be exploited as long as it is profitable.