Financial markets keep growing with more trading options and strategies that help traders increase their wealth and chances of landing profitable trades. Proficient traders utilise market inefficiencies to capitalize on opportunities to make money and grow their trading portfolio.
Arbitrage is a trading strategy that focuses on market imperfections and discrepancies between different marketplaces to make some income. This approach is more likely to bring immediate returns. However, it comes with several risks.
Nevertheless, a triangular arbitrage takes the usual arbitrage trading to another level by trading three different assets, benefiting from repetitive instant profits. Let’s explore triangular arbitrage and how you can implement it.
What is Market Arbitrage?
Let’s start by explaining the basics of the arbitrage trading strategy, which entails buying an asset from one marketplace and selling it at a higher price in another marketplace. This activity involves engaging in markets of different locations with different economic factors and exchange rates.
For example, a trader can buy Apple stocks from the London Stock Exchange at $100 and sell them on the New York Stock Exchange at $102, despite the trader buying and selling the same asset almost immediately, which usually results in losses.
However, the difference between the UK and US markets, local currencies and exchange rates result in fractional differences. These imperfections correct themselves almost seamlessly. However, traders take advantage of these tiny opportunities repetitively to make profits.
Introducing: Triangular Arbitrage
A triangular arbitrage strategy entails trading between three assets of the same nature. However, this approach is usually applied in the same market, such as the currency market.
Due to economic factors and discrepancies between local currencies, a trader may engage in a triangular arbitrage between the USD, EUR and GBP or execute three market orders on EUR/USD, GBP/EUR, and USD/GBP.
Thus, a trader can purchase Euros in exchange for their US Dollars. Then, exchange the EUR to GBP before trading back from GBP to the USD.
This process involves trading between three currencies of three different economies, leading to tiny differences and possibly gaining opportunities. However, this strategy requires careful analysis and research before execution because a trader may end up losing in this simple transaction.
Crypto Vs. Fiat Triangular Arbitrage
Triangular arbitrage is not limited to fiat currencies; it can also be done in cryptocurrencies, taking advantage of the tremendous volatility and dynamics of virtual coins and tokens.
For example, an investor may trade their USDT holdings for Bitcoins, then exchange from BTC to ETH before trading them back to USDT.
This three-fold exchange can give the trader outstanding gaining opportunities given the rapid changes and instability of the crypto market. However, this transaction must be well-researched and quickly executed because the market moves fast, and prices can settle quickly, rendering the trade unprofitable.
Triangular can also be implemented on uncommon crypto and fiat currency combinations, such as exotics in Forex and altcoins in cryptocurrencies. These less-traded options are usually characterised by higher volatility, which may come with higher gain opportunities.
How to Implement Triangular Arbitrage
The triangular arbitrage method can be done in two ways. The first way is through executing a buy-buy-sell market order, which entails the same as explained in the above examples. The trader buys asset B using asset A, then buys C using B, and finally sells C for A.
Simply put, this is similar to using A to buy C, but with a third asset between them.
The other way to execute is by buy-sell-sell order. This way, the trader buys B for A, then sells B for C and finally sells C for A.
Deciding the right triangular arbitrage approach requires a comprehensive understanding of how markets work and careful analysis to find the best arbitrage opportunity.
Advantages of Triangular Arbitrage
Once a careful market analysis has been done, a trader can engage in a triangular arbitrage trade and benefit from these advantages.
- Higher liquidity: Triangular arbitrage is usually conducted in the Forex and crypto markets, which are considered highly liquid markets, leading to faster execution times.
- Combined with automation: Traders can use trading automation and algorithms to identify and execute triangular arbitrage opportunities faster and more accurately.
- Lower risks: triangular arbitragers execute market orders almost immediately, without buying and holding for longer times, which mitigates the risks of unpredictable market change over time.
Final Remarks
Triangular arbitrage is a fascinating trading strategy that includes buying and selling three assets of the same market, such as fiat currencies and crypto coins. This approach allows traders to explore gain opportunities that take advantage of market imperfections and dynamic changes.
However, these opportunities can be tiny and require careful analysis to find the right timing and assets that bring profits besides executing them in a timely manner.
