Arbitrage
IntermediateArbitrage is the practice of profiting from price differences for the same or equivalent assets in different markets, by buying where the price is lower and simultaneously selling where it is higher.
In its pure form, arbitrage is risk-free: the buying and selling happen at the same time, locking in a profit regardless of future price movements.
For example, if gold trades at 1,900 per ounce in one market and 1,905 in another, a trader could buy in the first market and sell in the second, earning 5 per ounce before transaction costs. Similarly, if a company's shares are listed on two stock exchanges at slightly different prices after adjusting for exchange rates, traders can profit from the gap.
Arbitrage plays an important role in keeping markets efficient. As traders exploit price differences, buying pushes up the lower price and selling pushes down the higher one, until the gap disappears. In modern markets, these opportunities are often tiny and last only fractions of a second, so they are mostly captured by sophisticated firms with fast computers.
Many strategies described as arbitrage involve some risk. Merger arbitrage, for example, involves buying shares of a company being acquired, betting the deal will be completed. Statistical arbitrage uses models to exploit price relationships that usually, but not always, hold.
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