Triangular arbitrage strategies
Triangular Arbitrage is a risk-free trading strategy that aims to exploit discrepancies in exchange rates between three different currencies in the foreign exchange market. The strategy involves three trades, exchanging an initial currency for a second, the second currency for a third, and finally the third currency back to the initial. If the final amount is higher than the initial, a profit is made.
Here's a simplified step-by-step breakdown:
- Start with a currency: For instance, USD.
- Exchange it for a second currency: Convert USD to EUR.
- Exchange the second currency for a third: Convert EUR to GBP.
- Exchange the third currency back to the initial: Convert GBP back to USD.
If, after these transactions, you end up with more USD than you started with, you've successfully executed a triangular arbitrage. The discrepancies that make this possible often exist for only short periods, so speed and timing are crucial for execution.
The calculation for the arbitrage_value depends on the sequence of trades (BUY/SELL) for the currency pairs involved. The sequence determines how you move through the currencies in the triangular arbitrage loop.
Let’s break down the sequences for the pairs AUDUSD, NZDUSD, and AUDNZD:
… and so on for other sequences.
The idea is to start with one unit of a currency (e.g., 1 USD) and see how much of that same currency you end up with after completing the triangular arbitrage loop. If you end up with more than you started with (after accounting for transaction costs), there’s a potential arbitrage opportunity.
To implement this in code, you’d need to adjust the triangular_arbitrage_value function to account for the different sequences. You could add an additional parameter for the sequence or create separate functions for each sequence.
def triangular_arbitrage_value(pair1, buysell1, pair2, buysell2, pair3, buysell3):
"""
Calculate the triangular arbitrage value based on the given pairs and their BUY/SELL sequences.
Parameters:
- pair1, pair2, pair3: Current prices of the currency pairs.
- buysell1, buysell2, buysell3: 'BUY' or 'SELL' sequences for the respective pairs.
Returns:
- Arbitrage value
"""
# Initialize the starting value
value = 1.0
# Process the first pair
if buysell1 == 'BUY':
value /= pair1
elif buysell1 == 'SELL':
value *= pair1
# Process the second pair
if buysell2 == 'BUY':
value /= pair2
elif buysell2 == 'SELL':
value *= pair2
# Process the third pair
if buysell3 == 'BUY':
value /= pair3
elif buysell3 == 'SELL':
value *= pair3
return value
# Example usage:
pair1_price = 0.75 # Example price for AUDUSD
pair2_price = 1.07 # Example price for AUDNZD
pair3_price = 0.70 # Example price for NZDUSD
value = triangular_arbitrage_value(pair1_price, 'BUY', pair2_price, 'SELL', pair3_price, 'BUY')
print(f"Arbitrage Value: {value:.4f}")
# If the value is significantly greater than 1, there's a potential arbitrage opportunity.
if value > 1.01: # 1.01 is used as a threshold to account for transaction costs and other fees.
print("Potential arbitrage opportunity!")
else:
print("No arbitrage opportunity.")