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Tuesday, March 11, 2008

Triangle Forex Arbitrage Strategy

Triangle or triangular arbitrage is a Forex trading strategy, which is theoretically ‘risk free’. As the name suggest, triangle arbitrage includes trading 3 different currency pairs almost simultaneously to profit from exchange rate difference between them.

In global Forex market, the price of one currency pair depends on the price of one or more other currency pairs. The basic formula for the relationship of three related currency pairs, having 3 different currencies, is as follows.
AAA/BBB x CCC/AAA = CCC/BBB
Chance of triangular arbitrage occurs whenever this equation goes wrong. A triangle arbitrator buys BBB spending AAA, then buys CCC spending BBB and lastly returns to AAA selling CCC, capturing a small profit. The chance of profit is maximized by utilizing margin from brokers and trading with higher amounts.

For example take exchange rates EUR/USD = 0.6522, EUR/GBP = 1.3127 and USD/GBP = 2.0129. With $500,000 one can buy 326100 Euros, using that he can buy 248419.29 Pounds. He can now sell the pounds for $500043.19. Thus he can earn a profit of $43.19.

In today’s Forex market, the chances for triangle arbitrage are getting rare. Even if there is one, it last only for seconds. Thus for profiting from triangular arbitrage traders need advanced trading systems, programmed for automated trading. Taxes and fees may also reduce the profit.

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