Forex Arbitrage is the name of the strategy employed by seasoned investors to take advantage of varying rates of the same currency in different Forex markets. This is a strategy that helps traders to book profits without actually waiting for the price of a currency to move up or down relative to another currency. Thus an experienced investor, when he/she recognizes the price differences of the same asset in different markets can actually buy the same in a market while selling it in another market.
Forex Arbitrage is only one of the various strategies tried by traders in currency markets, especially day traders. The fundamental principle behind Forex Arbitrage is to earn money at the expense of inefficiencies in the markets that arise from time to time but only for very short periods of time. This means a trader must not only be alert but also take fast decisions as trade executions, if they suffer from time lag, can actually cause losses if price differences between markets vanish by the time execution of trade takes place.
Forex Arbitrage is a complex strategy as it involves trading in three different currencies and 3 different combinations of currencies that one can derive using these currencies. For a successful Forex Arbitrage, you need to make a minimum of three currency trades where with the final trade you buy back the same currency that you sold in the first trade. This means if you had Euros in your account at the start, you will have Euros in your account after buying them back at the end of the cycle in Forex Arbitrage. You end up owning more Euros than you had in your account before arbitrage, taking advantage of the market inefficiencies that arise frequently for brief time periods.
For example, you can start with USD in your account and buy Euros with them. In the next trade, you buy Pounds with your Euros and in the final trade you convert your Pounds into dollars once again. The end result of these three trades is an increase in your money in the trading account. One can get back to the original currency in his account completing many more trades instead of just three trades.