Stock Arbitrage Trading Explained

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Arbitrage is done my big financial institutions. It is simultaneous selling and buying of two similar financial products to take benefit of difference in prices.

Though arbitrage is no more popular now, it was very popular a few years ago. Trading volumes were less so arbitrageurs took a lot of benefit. However now trading volumes have increased and there are a lot of systems that make sure there is not too much volatility in markets.

But still arbitrageurs exist.

Some traders use automated trading systems to arbitrage.

One Simple Arbitrage example – This is called Pairs Trading

A trader can buy one stock and at the same time sell one stock from the same business sector. If one side move comes more in that sector the arbitrageur can make money. However this is very risky due to the nature of stock markets.

Earlier it was not that hard because stocks of the same business sector used to move in same direction, however now stocks at company dependent not sector specific dependent.

One Example of Risky Arbitrage

Acquisition of one company of another company is very common. This news is open to all and is known sometimes 30 days before the actual acquisition actually takes place. Suppose news has come that company A will acquire company B, then arbitrageurs will buy stocks of company B and sell stock of company A. This is very risky arbitrage strategy but there are people who try it.

Selling in One Exchange and Buying in Another

This can be done my institutional investors only who have the right to sell or buy the same stock at different exchanges.

Suppose a company stock is listed in New York Stock Exchange (NYSE) and also in London Stock Exchange (LSE). Now because of different demand and supply, prices can be different in different markets. Let say company A is 45 in NYSE but 46 in LSE then an arbitrageur will sell in one stock market and buy same number of shares in another. After sometime one will give profit.

But they need to enter large positions to make huge gains.

Please note that earlier not many traders had the software or technology to know these arbitrage opportunities but in this modern world there are technologies, media, software etc that almost everyone has access to. Therefore these arbitrage opportunities are no longer available. Still arbitrageurs exist and try to take benefit.

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