Pros and Cons of FOREX Arbitrage
- Higher transaction costs. The trader must pay the bid-ask spreads on three separate trades.
- Higher margin requirements. Roughly three times the margin is necessary to execute the arbitrage strategy and odd-lot trading may be required for the small capital investor.
- Precision timing is required.
- Multiple dimensions. The trader must thoroughly understand the arbitrage mechanism before determining which currency pairs to buy and which to sell. Each arbitrage package consists of two buys and one sell or one buy and two sells. Miscalculating any one of the three trades can cause disaster.
- Advanced monitoring techniques are usually required. This means calculating the preceding analysis on several pairs simultaneously in real time and will involve a software program that continually analyzes streaming quotes. It is possible to perform these tasks manually, but the trader must have a high tolerance for tedium.
If you take a snapshot of all the major pair cross-rates at a given time and use transitivity to calculate from one end to the other, you will find the whole is not the same as the sum of the parts. The trick is catching those anomalies as they stream along in real time. Think low latency -- very low latency.
By Michael Duane Archer