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Question: Trade Mechanics of Triangular Arbitrage

  • Post #1
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  • First Post: Mar 9, 2010 11:51pm Mar 9, 2010 11:51pm
  •  Higa
  • | Joined Mar 2010 | Status: Junior Member | 1 Post
Before I even ask this question, please allow me to be very clear.... I have no intention of attempting a triangular arbitrage trade(for reasons of practicality ). The reason why I've chosen triangular arb. as a case study is because it utilizes concepts that, if understood correctly, could help me in the future.

Bear with me please.....

My question concerns mostly the mechanics underlying what happens after one attempts a triangular arbitrage trade, and the consequences that these mechanics would have on a trade. The term "mechanics" in this case refers to: order processing protocols, accounting protocols etc.... i.e..... things that are mechanical or algorithmic in nature.


Without getting bogged down in the details of a triangular arbitrage transaction, here is my general understanding of what would transpire in a hypothetical trade. In this hypothetical trade, we're intentionally neglecting practical issues like spreads, scarcity of opportunity, time lags, etc....
1.) An opportunity for triangular arbitrage presents itself.
2.) The trader opens up the appropriate three positions simultaneously.
(possibly via an EA)
3.) The trader closes those three positions at the same rates they were
opened.(possibly via an
EA)
4.) Profit is realized.

So here is where my confusion begins.....
Based on my understanding of what happens when you open and then close a trade, NO profit should be made. The Reason: Whenever you close a trade you are simply reversing the process of which you opened it. Example: Open trade -> currency1/currency2 = Long currency1 and Short currency2 . Close trade = Short currency1 and Long currency2. Now apply this method to steps 1-4 given above. It appears that Pair1 close would cancel Pair1 open, and Pair2 close would cancel Pair1 open, etc...

The only way that I can think of for there to be any profit would be if either:
1.) The trader could specify Exactly what he wanted done with his bought
currency. Example: Buy EURUSD, then take the EUR just bought and
exchange them for GBP by shorting the EURGBP, then take the GBP
just bought and exchange them for dollars by shorting the GBPUSD
pair. However, I think that each trade is managed independently, and
there is no "communication" between trades thereby making it
impossible to accomplish this. The above method would require
very specific debiting and crediting.

OR
2.) If while all three trades were open, the amounts bought and sold were
NETTED together. The netted amounts should all sum to zero
EXCEPT for the USD(or home currency). This difference is where the
profit would come from. This would work for this example, but it just
seems like all hell would break loose on the accounting end if they just
started summing amounts without regard to exactly which trade it was
associated with.

So as you can see the accounting practices and/or trade matching protocols etc... effect the outcome. Any ideas on what ACTUALLY happens?

Thank you to anybody and everybody who even takes the time to read through this post. I appreciate your effort/curiosity.
  • Post #2
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  • Edited 3:52pm Mar 11, 2010 3:30pm | Edited 3:52pm
  •  LuboLabo
  • Joined Sep 2008 | Status: Order Flow Trader | 880 Posts
Triangular arbitrage take is strategy from the market inefficiency or a state of imbalance between three foreing excange market ........http://en.wikipedia.org/wiki/Triangular_arbitrage.


The process of converting one currency to another, converting it again to a third currency and, finally, converting it back to the original currency within a short time span. This opportunity for riskless profit arises when the currency's exchange rates do not exactly match up. Triangular arbitrage opportunities do not happen very often and when they do, they only last for a matter of seconds.

As an example, suppose you have $1 million and you are provided with the following exchange rates: EUR/USD = 0.8631, EUR/GBP = 1.4600 and USD/GBP = 1.6939. With these exchange rates there is an arbitrage opportunity: Sell dollars for euros: $1 million x 0.8631 = 863,100 euros Sell euros for pounds: 863,100/1.4600 = 591,164.40 pounds Sell pounds for dollars: 591,164.40 x 1.6939 = $1,001,373 dollars $1,001,373 - $1,000,000 = $1,373 From these transactions, you would receive an arbitrage profit of $1,373 (assuming no transaction costs or taxes).

Lubo.
If I know how, I tell You!! Few but Good!!
 
 
  • Post #3
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  • Mar 18, 2010 1:34pm Mar 18, 2010 1:34pm
  •  cwitts
  • | Joined Mar 2010 | Status: Member | 7 Posts
Ok, I’m new here and this will be my first post. After some time going over the triangular arbitrage idea, I developed a little system that runs in an old beat up laptop with XP and Excel 2003. It communicates trough the Fix Gateway and is able to place up to 4 confirmed combinations (rings, 3 legs, etc.) per second. It calculates more than 100 currencies real-time and places combinations with positive results automatically. Basically I start the system, sit down, and watch it taking decisions for me. The only input I have to do is when the orders get confirmed in negative do to slippage (normal market movement, latency, last look, etc.).
The only problem I have so far is what to do with this thing? I have been banned from couple of brokerage houses for many reasons and the few others lack of proper liquidity providers.
Sorry Metatraders real triangular arbitrage does not work in those types of video games platforms. Don’t get mad, arbitrage is a function of exchange not trade! I don’t leave positions open or care about interest rates. I’m only looking for the price discrepancies.
I hope somebody has a good idea!
The only one that can say that triangular arbitrage is a risk free investment is someone that has never done it.
 
 
  • Post #4
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  • Apr 2, 2010 6:12am Apr 2, 2010 6:12am
  •  madar
  • | Joined Nov 2009 | Status: Junior Member | 2 Posts
I might be able to help out. I have access to high liquidity, and am about to embark on writing the code to get this done. Perhaps if we work together we can make something happen.
 
 
  • Post #5
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  • May 3, 2010 1:28pm May 3, 2010 1:28pm
  •  efosasuccess
  • | Joined May 2010 | Status: Junior Member | 1 Post
i'm interested in joining you guys, and have some great ideas about this strategy, one of them is, this could work if we make use of some exotic currencies too on the hypothesis that the'll lag behind. holla ma
 
 
  • Post #6
  • Quote
  • Jun 13, 2010 12:41am Jun 13, 2010 12:41am
  •  fxsoftware
  • | Joined Mar 2010 | Status: Member | 13 Posts
I have it all done and it took many many a years and money. Let's all make what I have better instead of you all starting over
 
 
  • Post #7
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  • Last Post: May 9, 2011 9:07pm May 9, 2011 9:07pm
  •  nondisclosure00
  • Joined Apr 2007 | Status: Gettin' kick in the nutz every day! | 835 Posts
I'd like to help out on this if the thread isn't dead.
 
 
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