Why you cannot make profits by trading across markets

Whatever strategy you are coming up with already exists and exploited to the fullest.

Every new method invented and discovered comes under making the markets efficient, narrowing the gap of profiting. Unless you have an algorithm to find pricing discrepancies and that should be a time efficient code, better than at least half of the world’s algorithm traders.

Trading across platforms has been a strategy since 1990s, been in existence for so long time has made the strategy well known to every trader and to profit from the differential pricing.

  • Same securities must trade at the same price across markets, regardless of exchange rates.
  • Securities with similar cash flows should trade at the same price regardless of future happenings.
  • A security with known prices (highly certain) must trade at a price discounted by the risk free rate.

Pure arbitrage is when similar assets of same or comparable cash flows, regardless of future even should be priced equally. When this condition fails to be in practice, arbitrage arises. In its purest sense arbitrage is risk free, whenever traders look for the same kind of market inefficiencies they tend to pump in money to exploit the risk free high return.

A simple and understandable arbitrage can be seen in difference in prices of a stock price in a market. Prices of the security at two different markets will change according to the trading volume of the security, which is impossible to keep it the same in two different markets. Millennial companies are listed globally, more than the home market, may significantly show price differences as controlling markets within the country is onerous imagine how well can a global markets be integrated. Arbitrage is buying the security that is priced lower and shorting the same which is highly priced in a different market.

Market takers burn fingers

  • More than normal trading capital
  • People with more skills
  • Powerful softwares
  • Speedy transactions

All these offset retail traders profiting a risk free arbitrage. The time retail investors put fingers in above average performers would have pumped in so much money to close the gap, the burn is due to transaction costs which seldom be paid from the profits. Arbitrage trading would never be a retail investor’s league unless a machine is working to find pricing discrepancies. Market makers in this case are generally the hedge funds who with sophisticated trading infrastructure, skilled position takers and business contacts aid them to react instantly.

Stock price arbitrage that doesn’t depend on corporate events are hard to find, since they had been in practice for so long time, the stock exchange has introduced an anti arbitrage mechanism that equalises the price of all the global markets in which the security is trading. Although implementing successful strategies in the market make them efficient, this mechanism without traders keep the market efficient.

Still, there are arbitrage strategies that can be implemented within a market, which is on similar securities.

Pairs Trading

Where the investor has to locate two securities that are strongly correlated. Regardless of their fundamental similarities, like the business they are involved with, the sector they play, the characteristics of the security is scrutinized to find pairs trading arbitrage. Once the securities are found, the divergence should occur to profit, as the price of one stock moves and the other being at the same or vice versa. Since they are correlated the price has to go with one of the security. Short or long on the securities to profit.

In arbitrage profiting, skill and speed are the assets of a trader. Once the news hits the markets, the trader has to know how will the market react to such news and what kind of position he/she has to take inorder to profit from the news. Whether it is a Takeover and merger arbitrage, derivative pricing, Liquidation arbitrage, speed and skills are the assets.