What is arbitrage in trading?

Arbitrage is the practice of capitalizing on price discrepancies of the same asset across different markets. It involves buying an asset at a lower price in one location and simultaneously selling it at a higher price in another. This process aims to lock in a risk-free profit based on the price differential. For example, if a stock trades at $100.00 on the New York Stock Exchange and $100.05 on the London Stock Exchange, an arbitrageur buys the shares in New York and sells them in London. The $0.05 difference represents the gross profit. Modern markets rely on high-frequency trading algorithms to identify these gaps in milliseconds, as price inefficiencies are typically small and short-lived. While the concept appears risk-free, traders face execution risks. Slippage, transaction costs, and latency can erode small margins. If the price shifts during the execution of the trade, the profit may disappear or result in a loss. Trading involves significant risk, and market participants must account for fees and liquidity constraints before attempting these strategies. Successful arbitrage requires advanced technology and rapid order execution to compete with institutional systems.