Triangular Arbitrage

Triangular arbitrage is a type of arbitrage that involves the simultaneous purchase and sale of the same asset in three different markets. The goal is to profit from the difference in prices between the three markets.

To understand how triangular arbitrage works, let's consider an example. Suppose the price of gold is $1,000 per ounce in the United States, €1,200 per ounce in Europe, and £1,100 per ounce in the United Kingdom. If we can buy gold in the United States and sell it in Europe, we will make a profit of $200 per ounce (€1200 - $1000). We can then use the euros we earn to buy pounds, and use the pounds to buy gold in the United Kingdom. This will give us an additional profit of £100 per ounce (£1100 - €1200). In total, we will have made a profit of $300 per ounce (€200 + £100).

Of course, in reality, there are costs associated with trading, such as commissions and fees. These costs will reduce the profit that can be made from triangular arbitrage. However, if the difference in prices between the three markets is large enough, it is still possible to make a profit.

Triangular arbitrage is a relatively low-risk strategy, as it does not involve any speculation on the future direction of prices. However, it can be difficult to find opportunities for triangular arbitrage, as the prices of assets in different markets are constantly changing.

In addition, triangular arbitrage is often not possible due to restrictions on the movement of capital between different countries. For example, the government of a country may impose capital controls that prevent investors from moving money out of the country. This can make it difficult to buy assets in one country and sell them in another.

Despite these challenges, triangular arbitrage can be a profitable strategy for experienced traders. It is a good way to make money in the short term, and it can also be used to hedge against risk.