Since you are a very savvy trader, before you trade, you already know what the first question you should ask.
“What are my risks?”
Completely correct! Before carrying out arbitrage trading, you must always measure the maximum risk you can bear to determine whether you are worth trading.
In our last lesson, our new foreign exchange trader Zhang San, his maximum risk tolerance is $9,000. Once his loss touches $9,000, he will be automatically closed by the system.
That doesn’t sound very good, does it?
Remember, this is the worst possible situation for Zhang San, because he has not fully realized the value of the stop loss.
When carrying out arbitrage trading, you can also use a stop-loss strategy just like ordinary directional traders.
For example, if Zhang San wants to control its maximum loss at $1,000, then he can set his stop loss at any price that causes him to lose $1,000. As long as he holds a position, he can still earn interest income.
While you are paying a low interest rate for the financial instrument you borrowed or sold, you are getting a higher interest rate gain on the financial instrument you purchased. Therefore, your profit comes from the spread between the two financial instruments.
Arbitrage trading is another way to make money in the foreign exchange market. It does not require buying low and selling high, and buying low and selling high every day is a big challenge for traders.
When traders feel the existence of risk and are confident enough to buy high-yield currencies and sell low-yield currencies, the implementation of the carry trade strategy works best. Current economic indicators may not be good, but the economic outlook needs to remain positive.
If a country’s economic prospects are not good, no one is willing to risk buying the country’s currency. To put it simply, when investor risk aversion is low, it is most suitable for carrying out arbitrage transactions.
When the risk aversion sentiment is high, the effect of arbitrage trading is difficult to guarantee.
When the risk aversion sentiment is high, investors are not willing to buy high-yield currencies, or tend to lower their positions in high-yield currencies.
When economic conditions are uncertain, investors tend to invest their funds in safe-haven currencies, which have lower interest rates, such as the US dollar and Japanese yen.
Finding the right currency pair to carry out arbitrage transactions is very easy. As long as the following two points are met, we can consider carrying out arbitrage transactions.
- Find currency pairs with high spreads;
- Find a currency pair that remains stable, or find a currency pair that is in an upward trend, and a currency with a high rate of return maintains its appreciation in the currency pair.
Economic and political factors are changing the world every day. The spread factor between currencies may also change, which may prompt popular arbitrage transactions, such as yen arbitrage transactions are no longer favored. Therefore, when carrying out an arbitrage transaction, you should set up a stop loss just like a general directional transaction.
As long as it is used properly, arbitrage trading and directional trading strategies will bring a steady stream of profits to your account.