LEVEL II
Triangular arbitrage is a trading strategy that takes advantage of price differences in the foreign exchange market to generate a profit. It involves three currencies and three exchange rates. The basic idea is to convert one currency into another, and then back into the original currency, taking advantage of any discrepancies in the exchange rates along the way.
Triangular arbitrage works by taking advantage of differences in the cross rates between three currencies. For example, consider a scenario where the cross rate between currency A and B (A/B) is lower than the cross rate between currency B and A (B/A), and the cross rate between currency B and C (B/C) is lower than the cross rate between currency C and B (C/B). In this scenario, a trader could convert currency A into currency B, and then convert currency B into currency C, and finally convert currency C back into currency A. If the cross rates are such that the conversion results in a profit, the trader could then repeat the process to generate a profit from the difference in the cross rates.
In summary, triangular arbitrage is a trading strategy that takes advantage of differences in the cross rates between three currencies to generate a profit. The strategy involves converting one currency into another, and then back into the original currency, taking advantage of any discrepancies in the exchange rates along the way.
