When it comes to economics and finance, arbitrage is an invaluable way to take advantage of the price difference between two or more markets in order to capitalize on the imbalance between, and make a profit.
Arbitrage Trading
Cryptocurrency trading is not that different from stock or Forex markets in that there are many exchanges, each one with their determining market price factors which often causes an imbalance in price between those exchanges.
In addition to watching the usual market analysis for the best buy or sell opportunities, now you’re looking for parallels with your token to essentially shop for where you can get the best selling price.
How arbitrage works:
Let’s assume the 1st exchange sells XYZ cryptocurrency at $5 per coin, and the 2nd exchange sells the same XYZ cryptocurrency at $7 per coin.
For successful Arbitrage trading, you can start by:
[rml_read_more]
- Buying XYZ cryptocurrency at $5 on 1st Exchange.
- Transfer XYZ cryptocurrency from 1st Exchange to 2nd Exchange.
- Sell XYZ cryptocurrency on 2nd Exchange at $7 per coin.
In this scenario, you’ve made a $2 profit just for paying attention to the different exchanges.
Although arbitrage trading looks straightforward on the surface, be mindful of the risk
involved when following this trading paradigm.
What to look for in arbitrage trading
- There is significant risk if there is a sudden rise in volatility. This can happen within seconds as you wait for transfers or count the moments to complete the arbitrage process. Breaking news events may distort the exchange rates and result in an unprofitable transaction on your part. Remember, there are fees associated to sending tokens off an exchange!
- Sudden drops in the volume for the price you want can cut into your profit or even cause a loss.
- Transaction fees and delays in trade execution.
Weigh the cost comparison of staying on one exchange against the extra fees for transfers and exchange fees for completing transactions.
How to minimize arbitrage risk
If you’re going to try your hand at arbitrage, there are some key things to practice and watch for: 1. Have some fiat money available on both exchange where you plan to make trades, and 2. Review the level of liquidity on both exchanges to get the number of buy and sell orders for their price points.
Understanding the Order Book
Most cryptocurrency exchange platforms allow traders to see the order book, which shows different price levels where all the buy and sell orders have been placed.
An order book on most exchange platforms is updated in real time, showing the liquidity level of the cryptocurrency.
A market is liquid if traders can buy and sell a cryptocurrency without significantly affecting its price. An increase in trading volume results in higher liquidity.
The green area shows all buy orders, while the red area indicates the sell orders.
The horizontal axis shows the price which market participants are willing to exchange a cryptocurrency, and the vertical axis indicates the number of open orders for each price point.
Let’s walk through a simple example. If you create an immediate sell order for one Bitcoin at $8000 and it is sent to the order book, your order will remain in the order book until it is filled by one or several buyers until your sell order is satisfied.
The order book is great for gauging the liquidity of the market as some traders may use it to manipulate other traders’ market perception.
Traders are advised to choose exchanges with higher liquidity to avoid pump and dump schemes.
Trading Resources
You won’t go very far in trading without some tools and knowledge. In a previous article we mentioned the trading and analytics platform MetaTrader5, but there are other trading resources to help you along.
TradingView
TradingView.com is an excellent resource for analyzing cryptocurrencies, fiat currencies, and different asset classes.
This platform allows you to develop trading ideas, experiment with technical indicators, price action patterns, and much more. A Crypto Trader News review on TradingView is forthcoming, but for now, understand that expert and beginner traders make use of TradingView for cryptocurrency analysis and charting to make better profits.
CoinGecko
CoinGecko is a coin market ranking chart app that ranks digital currencies by various aspects such as developer activity and liquidity, a good alternative to CoinMarketCap for a visual on different cryptocurrency market data.
CoinMetrics
Maybe geared more toward investors and experienced traders, CoinMetrics is a crypto asset and network data provider that allows its users to create downloadable charts which uses up to 66 metrics for their assets.
In closing, we want to point out that there is always risk when it comes to trading, whether it is a straight trade or arbitrage. Observation, analysis of the market data, and understanding volume and liquidity will give you a leg up on other traders.
Disclaimer
Content provided by CryptoTraderNews is for informational purposes only, and should not be construed as legal, tax, investment, financial, or other advice. All information is of a general nature. As always, there is risk with any investment. In exchange for using our products and services, you agree not to hold CryptoTraderNews Pro, its affiliates, or any third party service provider liable for any possible claim for damages arising from decisions you make based on information made available to you through our services.
