Definition
The term market arbitrage refers to the practice of selling a security in one market and buying it in another. Market arbitrage is possible when the price of the same security is not identical in two different markets.
Explanation
While stock exchanges are considered efficient markets, there are instances when the mispricing of securities provides the opportunity for profits through market arbitrage. This approach requires the trader to sell a security in one market, while buying it at a lower cost on another. Market arbitrage can only occur when the price of the same security is not identical on two different exchanges.
Market arbitrage is only possible because stock markets are not perfectly efficient. If they were, the price of the same security would be identical on all exchanges. Traders realize markets are not perfectly efficient and exploit this imperfection to make a profit. For an investor to create a profitable transaction, not only must a price differential exist between two markets, but the total difference must be in excess of the brokerage fees paid on the orders.
Example
Company XYZ's stock is currently trading on the NASDAQ for $21.25 per share, while it is trading on the Euronext market for $21.35 per share. An alert trader notices the opportunity for market arbitrage and immediately buys 10,000 shares of Company XYZ on the NASDAQ for $212,500 and sells those same 10,000 shares on the Euronext market for 213,500; realizing a profit of $1,000 on the transaction.
Related Terms
The term high-frequency trading refers to computerized platforms with the capacity to execute a large number of transactions in a relatively short timeframe. High-frequency trading is limited to those institutions with direct feed lines to an exchange.
Moneyzine EditorJanuary 19th, 2024- The term super display book refers to a computerized system used by the NYSE to display, record, and execute orders for securities. The super display book routes orders directly to the correct specialist for immediate execution.Moneyzine EditorSeptember 21st, 2023
The term mixed lot refers to an order that contains a combination of both round and odd lot orders. A mixed lot for stock is any order that is greater than 100 shares, but not a multiple of 100 shares.Moneyzine EditorFebruary 8th, 2024
The term designated order turnaround system refers to a computerized network that routes instructions to exchange specialists, thereby bypassing brokers. The designated order turnaround system quickly executes orders to both buy and sell relatively large baskets of stock.Moneyzine EditorJanuary 16th, 2024
The term automated order system refers to a computerized network that transmits instructions to the designated order turnaround system or to floor brokers working on the exchange. The automated order system routes the trader's instructions so they can be quickly executed.Moneyzine EditorSeptember 18th, 2023- The term statistical arbitrage refers to the practice of using sophisticated mathematical models to identify potential profit opportunities from a pricing inefficiency that exists between two or more securities. Statistical arbitrage requires the use of high speed computers, computational models, as well as complex trading systems.Moneyzine EditorSeptember 21st, 2023
- The term quantitative trading refers to the practice of using sophisticated mathematical models to identify opportunities to buy and sell securities. While quantitative trading is oftentimes associated with large financial institutions, the approach is also used by individual investors.Moneyzine EditorSeptember 21st, 2023
The term flash trading refers to the practice of using high-speed computers, and low latency communication lines, to view orders before they reach the general marketplace. As is the case with high-frequency trading, flash trading is limited to those institutions with direct feeds to an exchange.Moneyzine EditorJanuary 18th, 2024
