1. What is arbitrage trading?

This type of trading capitalizes on imbalances in prices between markets.

Simply put, this is when an asset is simultaneously bought and sold in two markets — often because they are being sold at slightly different prices.

As an example, shares in a technology company might be on sale for $35 on the New York Stock Exchange, but available for $35.10 in London. Sure, the difference is small — but speedily bulk buying the shares at the lower price and selling them for a higher price can result in a tidy profit for an eagle-eyed trader. This concept captures the very essence of arbitrage, and it is relatively low risk when compared with other strategies.

Now, you may be wondering: How can such inefficiencies occur? Well, there are a multitude of reasons. Fluctuations in currencies can mean that stock ends up undervalued on foreign exchanges. Markets are also imperfect, and synchronicity between every exchange can be hard to achieve. Asymmetrical information between buyers and sellers is also a breeding ground for arbitrage. Alas, with such tiny profit margins, trading fees can ultimately mean that many arbitrage opportunities make little financial sense to pursue.

Arbitrage can work across a range of financial instruments beyond stocks — bringing us very nicely up to our next question.