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Arbitrage is a fairly growing financial instrument where traders purchase a product on one market and sell it on another immediately to make a profit. Traders use arbitrage to profit in the differences in prices between markets selling the same product. Can you get rich doing arbitrage? Well, it depends on a lot of factors.
What Commodities or Assets are involved?
Nearly every product sold by more than one market at different prices can be arbitraged for profit. You can purchase a coffee maker on retailer ‘A’ for $200, for example, and if the same coffee maker is on demand on retailer ‘B’ at $220, you will have made $20.
Arbitrage is generally not very convenient when selling physical goods because of such issues as transportation and storage. Again, arbitrage work best by capitalizing on short-term price differences which means that any changes in value during the transportation period will work against your favor.
Types of Arbitrage Trading
- Location/Spatial Arbitrage
This type of arbitrage trading takes advantage of the differences in demand for particular assets in two different locations. Location arbitrage is the simplest form of arbitrage. If an air filter costs $600 in a certain market in Paris and the same air filter costs $1,000 in London, you can purchase the filter in Paris and sell it in London.
Assuming the cost of transporting the Air Filter from Paris to London cost $50 including any additional charges, you will make a profit of $350 in the process. While location arbitrage is a simple concept, you have to physically purchase the product and spend time and resources to complete the deal. Sometimes the product on sale could decrease in value, leading to further losses on your part.
- Merger Arbitrage
Some investors buy the stocks of a company when it’s about to be merged with another company and later sells the stocks immediately after the merger. This type of trading is a huge risk as the value of the company’s stocks after the merger could go down.
There are numerous types of arbitrages. However, when most investors speak of dealing with this financial instrument, they refer to purchasing an asset like stocks or Bitcoins in one exchange and selling them immediately in a different exchange where their value is higher.
How Arbitrage Professionals make Money
- Stocks Arbitrage
Like any form of arbitrage, a stockbroker identifies a certain stock that varies in price on two different stock exchanges. If Apple’s stock sells at $1000 apiece on NYSE and $1005 on London Stock Exchange (LSE), the trader can buy in the New York Stocks Exchange sell at the LSE.
Stocks arbitrage assumes the following:
- The same security is trading at different prices on two different or more markets
- The security is traded at the same time at the two exchanges with the same currency
Merger arbitrage is also profitable, but it’s mainly profitable to experienced traders with huge sums of capital. Experienced traders generally have more skills, super-powerful computers and software programs that identify tiny price differences immediately.
- Cryptocurrency Arbitrage
Like stocks arbitrage, those averse to the topic of Bitcoins and altcoins know that different exchanges sell coins at slightly different prices. An experienced investor can arbitrage the prices of Bitcoins in an exchange like Coinbase versus the prices at Gemini Bitcoin exchange.
Let’s say Bitcoin is trading at $7,725 on Coinbase and $7,800 on Gemini; you can purchase a Bitcoin at Coinbase and sell it on Gemini for a profit of $80. Sounds pretty good, right? However, arbitrage is much more difficult with cryptos than with stocks or any commodity.
- Bitcoin buying Process-
Assuming you already have accounts on both crypto exchanges, it takes up to one hour for Bitcoin to move from your Coinbase account to your Gemini account. During this period, Bitcoin’s value on Gemini could depreciate back to $7,750 so that you only stand to gain $25.
- Bitcoin’s Fluctuation
Most cryptocurrencies, including Bitcoin, fluctuate every minute. Bitcoin is the most stable crypto coin, but at times it may fluctuate by up to 2% within an hour. This means that if you were aiming for a 2% profit by trading Bitcoin between Coinbase and Gemini, your profits could suddenly go down to zero within just that hour.
Deposit, Trading and Withdrawal Fees
One of the most important considerations when doing arbitrage trading is the costs of trading between the two markets. Let’s say Coinbase charges zero percent in fee to withdraw coins and transfer them to Gemini. Gemini does not charge deposit fees but asks for a trading fee of 2.5%. If your target was 5% in profits, you are down to 2.5% after making the trade.
Sending cryptocurrency from one address to another costs a fraction of your trading amount in fees. With Bitcoin, the trading fee goes to miners who help verify transactions as they go through the blockchain. While the average transaction fee for a Bitcoin transaction is 1.72%, it can get as high as 2%. For the same 5% you earlier targeted, you are down to a profit of 0.5% by the time you withdraw your Bitcoins into cash.
Learn more about sports arbitrage and how it’s different from other markets here.
Can you get Rich doing Arbitrage?
Arbitrage is not a get rich scheme. The profits to be made are usually low, and in most cases, it’s the large investors with huge sums of capital who profit. With profits ranging between 1% and 4%, trying arbitrage with any amount less than $10,000 will take a while to get you rich.
Fortunately, the tools needed to arbitrage are freely available online. There are different markets and commodities that can be utilized for arbitrage. But to make profits, it takes time. You have to commit lots of time to learn how things work. You have to invest in software and tools to help you analyze markets for opportunities before you start making money.
The Bottom Line
Only start arbitrage trading after you learn everything you need to learn. Start trading with small amounts and always do a great deal of research before investing in any assets or commodities.