Chances are good if you are a modern working adult thing you are familiar at least a little bit with how the stock market works. Perhaps you have a 401(k) that you invest in regularly, or perhaps you have taking it a step further and you even do some day trading on your own. Perhaps you know nothing about investing in the stock market, but you have at least a little familiarity with it because you have seen movies like Wall street, the big short, or the Wolf of Wall Street. Despite all of the ups and downs of the economy in the last few years, there are still thousands of people that make their living through day trading on the stock market. One way that they can do this is through arbitrage calculation. Arbitrage can be easy enough to explain but very complicated to understand. Once you have an understanding of arbitrage, then you can use that knowledge to help you pad your own bank account.
So, what is arbitrage and how does it work? In order to explain this, let’s make a small analogy. Let’s say that it is Christmas time and everyone is buying a certain toy at the toy store. You happen to notice that this toy is in high demand. You also happen to notice that a store that is down the street is selling that exact same toy for several dollars cheaper than the other stores. You quickly buy have all the toys at the cheaper price and then offer to sell them at the higher price that you saw at the other stores. You are not doing anything wrong, but you are taking advantage of the discrepancy in the pricing between the two different stores. This is similar to what arbitrage services do.
The trick to this kind of trading is that the small discrepancies are very short lived. Likely be store that was selling them for the lower price will quickly notice their error and will raise the price to match all of the other stores. Or perhaps the stores that were overcharging will see that another store is offering that same toy for less money and they will lower their price accordingly. That is also the nature of arbitrage. Many people do not have the time and patience to Watch the stock market that closely in order to take advantage of these price discrepancies. However that is how many day traders make the bulk of their income. They implement an arbitrage calculation strategy into the software that they use to predict trends in the stock market. While this is a perfectly legal practice, day traders have to be very careful to make sure that they are in compliance with their arbitrage trades. This is where things can get a little monkey. They must be sure that they do not engage in any kind of illegal practices such as insider trading or sharing information that they should not be sharing with other traders.