An arbitrageur is essentially a practitioner of what is known as arbitrage. In finance, arbitrage mainly involves the act of buying assets in one place and then quickly selling them in another. This is done in order to benefit from the price difference in the two places. That is, a particular financial asset may trade at a low price in one location compared to others, at one given time. Then an arbitrageur would buy it at the low price and sell it in the location where it is priced higher.
Typically, arbitrageurs trade in financial instruments like stocks, bonds, currencies and commodities. Generally, an arbitrageur will find opportunities when one of several conditions is present. One of these is the price discrepancy in two or more locations. For instance, any particular asset is expected to trade at the same price in all markets, though at times prices may diverge in different places for various reasons. In such cases, an arbitrageur would make his or her move to take advantage of the price discrepancy.
Another condition would be when two assets that are pretty much similar have different prices. Thus, arbitrage opportunities are not only confined to the same asset. For example, two different bonds with similar characteristics may only differ in prices. Arbitrage would then be feasible in such an occurrence.
To illustrate, it helps to consider a hypothetical stock trading at $30 US Dollars (USD) on the New York Stock Exchange (NYSE). Say the same stock is trading at $31 USD on the London Stock Exchange (LSE). Then an arbitrageur would buy a given amount of the stocks on the NYSE and simultaneously sell the same amount of stocks on the LSE, making $1 USD in profits per stock minus any fees. Arbitrage transactions such as these may provide a handsome profit, especially since the typical arbitrageur deals in large volumes. Information in the financial markets travels very fast; therefore, arbitrage opportunities vanish quickly, meaning arbitrage traders have to act fast as well.
In the foreign exchange market, there is what is referred to as triangular arbitrage, which essentially involves the buying and selling of three currencies virtually at the same time. For transactions such as this, an arbitrageur would exchange one currency for another, then exchange it again for a third, and finally exchange it back to the original currency. Basically, this is done when there are exchange rate mismatches between the three currencies in two or more locations, such as London and New York.
