What is Arbitrage?
Arbitrage mechanisms exist throughout capital markets. These mechanisms ensure relatively accurate pricing of financial products. However, when arbitrage mechanisms are absent, financial product prices can fluctuate significantly. A recent example is the substantial premium deviation of some tiered funds from their historical averages, which vividly demonstrates the importance of arbitrage as a cornerstone for financial product pricing.
Forex Arbitrage
In forex arbitrage, as long as transaction costs are lower than investment returns, arbitrage can continue indefinitely. Large investment firms often have low transaction costs in forex markets and strive to uncover and exploit such opportunities. Arbitrage mechanisms are the same across markets, whether involving the Swiss franc or the Japanese yen. Borrowing in low-yield currencies and investing in high-yield currencies depend on two main factors: currency volatility and low interest rates.
According to Barclays Bank, based on data from the last 20 years, the annual average return of arbitrage trading strategies is 7.9%, ranking second among the top five strategies. Today, let's talk about foreign exchange arbitrage trading: arbitrage traders are key participants in the foreign exchange market, with the interbank market being the most significant. The majority of banks' assets are in currencies, and it is inevitable for them to use continuous arbitrage trading to ensure the yield of currencies. Institutional and individual speculators also actively engage in arbitrage trading for the same purpose.
Arbitrage refers to profiting from the buy-sell price difference caused by fluctuations in foreign exchange rates. In the early days of the foreign exchange market, arbitrage strategies were primarily based on exchange rate differences between countries due to regional and temporal factors.
Types of Arbitrage Trading
There are many types of arbitrage trading, including the three most common ones: triangular arbitrage involving three currencies, carry trade, and covered arbitrage that leverages influence and predictive advantages.
With the development of computer technology, the "competition" between humans and computers has intensified. While most international foreign exchange traders still rely on subjective, manual trading methods, it is undeniable that the global trend increasingly favors using computers to execute trades. Quantitative trading is poised to become a key direction for future development.
At its core, finance is about identifying patterns from historical data in an attempt to predict the "most likely" outcomes. When it comes to analyzing patterns, nothing surpasses computers. The vast amounts of historical data and efficient processing capabilities give computers the foundation to excel. Quantitative trading is a method where computers sift through enormous datasets to identify high-probability events that generate excess returns, formulate strategies, and make decisions accordingly.
Quantitative trading eliminates human emotional factors. It acts like an unwavering, rational sword in the market, focused solely on delivering maximum efficiency and power.