How arbitrage as a trading strategy works?

Arbitrage is one of the several trading strategies which people can use. With this method, a trader benefits from the differences in prices of a cryptocurrency between two or more exchanges. As a result, a trader buys a cryptocurrency from an exchange with a lower price and sells to another with a higher price.

For example, if the price of bitcoin is $30 000 at KuCoin and $30 500 at Binance, a trader buys BTC at KuCoin and sells it at Binance, gaining $500.

Traders can also capitalize on price differences of a cryptocurrency when it is pegged in different fiat currencies.  An instance of this is when ETH priced in pounds is cheaper than ETH in Australian dollars (AUD). In this case, a trader buys the ETH using pounds and sells it for the Australian dollar.

This price difference occurs when there is a surge in the trading volume of a specific cryptocurrency such as BTC.  Usually, smaller exchanges which copy the prices of bigger exchanges do not adjust them at the same time, resulting in this discrepancy.

In some circumstances stiff competition among exchanges forces other exchanges to lower their prices.

Steps in using arbitrage trading method

There are a few steps which the trader should follow. Here they are:

•         Identify a cryptocurrency which exists on two exchanges.
•         Basing on order books of the two exchanges, calculate the interest
•         Buy the cryptocurrency from the exchange with a lower price and sell to that with a higher price.

This sounds very simple. However, is it really that easy? The process is not that easy as it involves much research to identify exchanges with different prices. Nevertheless, if a trader is on a social platform where people exchange information on crypto trading, the process becomes much simpler.

Our discussion above focused on simple or spatial arbitrage. Now, we need to discuss triangular arbitrage

Triangular arbitrage

Regarding triangular arbitrage, a trader takes advantage of price differences among three cryptocurrencies.  However, in this case, an individual should factor in transaction costs.  If one can profit from transacting with three cryptocurrencies, then one should go for that.

In most cases, the three cryptocurrencies exist on the same exchange, say Binance.  As an example, we consider BTC, BNB and ETH.  A trader buys BTC and converts it into BNB.  After that he/she converts BNB to ETH. The last step involves converting ETH to the original coin, BTC.

How to be successful with arbitrage?

The trader should access multiple listings at the same time to spot the price differences with ease.  To achieve this, many people use arbitrage tools and software systems.  For instance, by using arbitrage trading bots, traders can earn reasonable profit levels.

Conclusion

As noted above, arbitrage is a possible and profitable trading strategy if the people involved have the proper knowledge and expertise.  They should also use the latest technology including automated trading, as it is very quick and convenient.