Triangular arbitrage in forex refers to the process of trading three different currencies to exploit discrepancies in their exchange rates.
The idea is to trade one currency for a second currency, and then trade the second currency for a third currency, before finally trading the third currency back for the original currency.
By taking advantage of differences in exchange rates, the trader can potentially make a profit without any risk.
For example, suppose that the exchange rates for three currencies, A, B and C, are as follows:
- A/B = 1.2
- B/C = 1.5
- C/A = 0.8
If a trader has $100 in currency A, they can trade it for $120 in currency B (by using the A/B exchange rate of 1.2).
Then, they can trade the $120 in currency B for $180 in currency C (by using the B/C exchange rate of 1.5).
Finally, they can trade the $180 in currency C back for $144 in currency A (by using the C/A exchange rate of 0.8).
By going through this process, the trader has made a profit of $44 ($144 – $100) without any risk.
Note that triangular arbitrage opportunities are rare and usually disappear quickly, also this kind of arbitrage is usually done by sophisticated traders and institutions as it requires large capital, as well as high-speed trading algorithms and sophisticated software to identify these opportunities.
In short – it’s not as easy as it sounds, or looks.