Arbitrage: 101

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Happy Holidays traders!

Still no luck on that home run day I’ve been holding out for this month. I took a few average wins and one mid-sized loss over the course of last week. I’m up roughly $20k on the month and I’m hoping to push that above at $30k before the new year.

As I said last week, I thought I’d spend the last few days of the year talking a little about some alternative approaches to trading I and other day traders use to maximize returns and minimize loss. I’ll try to assess some of the pros and cons to each, but I’d encourage more in-depth research into each before experimenting with them, even in practice. There’s no use getting frustrated with something you don’t completely grasp.

Compared to shorting (which I covered a little bit last week), arbitrage is a slightly more complex gambit in some traders arsenals. Although again, the premise is deceptively simple: traders simultaneously buy and sell the equity, contracts and/or currencies related to a single asset to exploit price discrepancies and inefficiencies between markets.

Essentially, traders who employ arbitrage are doing the same thing as buying a discounted item at one store, then returning it to another store (with a lax return policy) for full price.

While arbitrage can be as simple as buying a stock on an American exchange and then selling it on the Canadian market, or simply finding a crossed market where the bid price of an equity is greater than its ask, the practice can be iterated upon to the point of absurdity. Advanced arbitrage traders can jump between three or more different equity markets or asset classes in order to optimize their gains.

Fast, careful and thoughtful execution is critical when delving into arbitrage, the cost and effort of which makes complex arbitrage somewhat exclusionary to most average traders. Being aware of the possibilities of trading between markets can be a valuable asset when the opportunity to exercise that knowledge arises.

Arbitrage trading, like the other approaches to trading I’ve covered or plan on covering this month, can be useful, and even highly profitable, when a trader understands how to best use them. Still, even beginner traders should familiarize themselves with the full spectrum of trading options in case they get into a rut with vanilla day trading.

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Posted In: EducationTopicsGeneralWarrior Trading
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