Forex Triangular Arbitrage

Risk-Free Arbitrage.

Bank Forex dealers are the prominent participants in Forex triangular arbitrage. Currency arbitrage keeps prices in related currency pairs in equilibrium. Therefore, if the prices in three corresponding currency pairs that are codependent become misaligned, an arbitrage opportunity presents itself. Triangular arbitrage is free from market risk because all the related trades are executed almost simultaneously. No long-term currency positions are held as part of this arbitrage strategy.

Bank Forex dealers are the prominent participants in Forex triangular arbitrage. Currency arbitrage keeps prices in related currency pairs in equilibrium.
Bank Forex dealers are the prominent participants in Forex triangular arbitrage. Currency arbitrage keeps prices in related currency pairs in equilibrium.

Forex Arbitrage Example.

For example, if the USD/YEN rate is 110, and the EUR/USD rate is 1.10, the implied EUR/YEN rate is 100 Yen per Euro. At certain times, the implied rate obtained from two related exchange rates is substantially different than the actual rate of the third currency pair. When this happens, traders can do triangular arbitrage by taking advantage of the difference between the real exchange rate and the implied exchange rate. For example, suppose that the implied EUR/YEN rate obtained from the EUR/USD and the USD/YEN rates is 100 Yen per Euro, but the actual EUR/YEN rate is 99.9 Yen per Euro. Forex arbitragers could buy Yen 99.9-million for Euro 1-million, buy Euro 1-million for US dollar 1.100-million, and buy US dollars 1.100-million for YEN 100-million. Following the three trades, the arbitrager would have Yen 0.100-million more Yen, about US dollars 1.0-thousand, than when they started.

Currency Arbitrage Causes Rates to Adjust.

In practice, the pressure put on Forex prices by currency arbitragers causes Forex rates to adjust so that further arbitrage would be unprofitable. In the above example, the Euro would appreciate relative to the yen, the US dollar would appreciate relative to the Euro, and the yen would appreciate relative to the US dollar. As a result, the implied EUR/YEN rate would fall while the actual EUR/YEN rate would fall. If prices did not adjust, arbitragers would become infinitely wealthy.

Speed and Low Costs Help Bank Forex Dealers.

Bank Forex dealers are natural arbitragers because they are fast traders and their transaction costs are relatively low. These trades generally present themselves in fast-moving markets when most traders are unaware of the changes in the related currency pairs.

What is the Forex Market?

Traders can use the forex market for speculative and hedging purposes, including buying, selling, or exchanging currencies. Banks, companies, central banks, investment management firms, hedge funds, retail forex brokers, and investors are all part of the foreign exchange (Forex) market – the largest financial market in the world.

Global Network of Computers and Brokers.

As opposed to a single exchange, the forex market is dominated by a global network of computers and brokers. A currency broker may act as both a market maker and a bidder for a currency pair. Consequently, they may either have a higher “bid” or a lower “ask” price than the market’s most competitive price. 

Forex Market Hours.

The Forex markets opens Monday morning in Asia and Friday afternoon in New York, the currency markets operate 24 hours a day. The Forex market opens from Sunday at 5 p.m. EST to Friday at 4 p.m. eastern standard time.

The End of Bretton Woods and the End of the US Dollars Convertability to Gold.

A currency’s exchange value was tied to precious metals such as gold and silver before World War I. This was replaced after World War II by the Bretton Woods agreement. This agreement led to the formation of three international organizations focused on promoting economic activity around the world. They were the following:

  1. International Monetary Fund (IMF)
  2. General Agreement on Tariffs and Trade (GATT)
  3. International Bank for Reconstruction and Development (IBRD)
President Nixon changes the Forex markets forever by announcing the US will no longer redeem US Dollars for gold in 1971.

As international currencies were pegged to the U.S. dollar under the new system, gold was replaced by the dollar. As part of its dollar supply guarantee, the government of the United States maintained a gold reserve equivalent to gold supplies. But the Bretton Woods system became redundant in 1971 when U.S. President Richard Nixon suspended the dollar’s gold convertibility.

The value of currencies is now determined by supply and demand on international markets instead of by a fixed peg.

This differs from markets such as equities, bonds, and commodities, which all close for a period of time, generally in the late afternoon EST. However, as with most things, there are exceptions for emerging currencies being traded in developing countries. 

Forex Funds and Managed Accounts are Popular Alternative Investments.

Forex funds and managed accounts have become popular alternative investments. The term “Alternative Investments” is defined as investment securities trading outside traditional investments like stocks, bonds, cash, or real estate. The alternative investment industry includes:

  • Hedge funds.
  • Funds of hedge funds.
  • Managed futures funds.
  • Managed accounts.
  • Other non-traditional asset classes.

Investment managers are known for delivering absolute returns, despite market conditions. Using strategy-driven and research-backed investment methods, alternative managers try to provide a comprehensive asset base and benefits such as less risk through lower volatility with the probability of improved performance. For example, currency funds and managed account managers are in the business of delivering absolute returns regardless of how the traditional markets, such as the stock market, are performing.


Forex fund manager’s performances will not be correlated to any of the conventional asset classes listed above. For example, if the US stock market is down, most US equity advisor’s performance will be down. However, the direction of the US stock market will not affect a Forex fund manager’s performance. Consequently, adding a currency fund or managed account to a portfolio of traditional investments, such as equities, stocks, bonds, or cash, is an excellent way to diversify a portfolio and potentially decrease its risk and volatility profile. 

What Is The Difference Between A Hedge Fund and a Managed Account.

A hedge fund is defined as a collection of managed  investments that uses sophisticated investment methods such as gearing, long, short and derivative positions in the domestic and global marketplaces with the objective of producing high returns (either in a total sense or more than a particular sector benchmark).

A hedge fund is a private investment partnership, in the form of a corporation, that is open to a limited number of investors. The corporation almost always mandates a substantial minimum investment. Opportunities within hedge funds can be illiquid because they frequently demand investors maintain their capital in the fund for a minimum of twelve months.