Do Brokers Allow Arbitrage?

Reviewing a merger companies list, the first thing that stands out is the large number of firms. “I think I’d like to invest in a merger”, you quietly say to yourself but do brokers allow arbitrage? Read on and discover your options and possibilities.

Do Brokers allow Arbitrage?

Yes, brokers allow arbitrage. Arbitrage is a legitimate, sophisticated trading strategy that capitalizes on the pricing differences of the same asset in different markets. To address the question, do brokers allow arbitrage? We must examine the following pertinent facts and considerations:

Market Access – Arbitrage trades are executed in different markets and, at times, simultaneously thus access to these markets is needed. Brokers provide market access on a specialized or limited basis.

Technology and Speed – Arbitrage price discrepancies are momentary and high-speed trading systems and technology are a necessity. Many brokers offer arbitrage frequency trading platforms to capture these fleeting profits. Brokerage services vary, as do platform speeds and reliability.

Transaction Fees – Frequent trading is inherent to an arbitrage strategy and so are transaction fees. Exchange and trade fees, currency conversion fees, and broker commissions can cannibalize trading profits. Conducting thorough research to select a brokerage with a competitive fee structure is paramount.

Capital Requirement – Brokers have minimum funding and balance maintenance requirements, and they are usually account type-dependent. Balance maintenance is the mandatory minimum balance you must maintain in your account. Margin accounts are accounts that allow you to borrow funds or securities from your broker to execute a trade. These accounts have required fund balances or security values to be eligible for active trading. It is important to know and understand your broker’s account requirements and all associated fees.

Risk Management – Arbitrage is low risk, not zero risk. An arbitrage strategy is subject to general economic risk, such as interest rate and liquidity risk. These are known as systematic risks. The strategy is also exposed to the specific risks associated with the individual companies involved in the trade. This is an idiosyncratic risk. Managed risk still impacts potential trade results and though brokers require adequate loss mitigation practices, a proper risk profile is always the investor’s responsibility.

Broker Policies – Brokers have specific arbitrage policies and may prohibit certain types of trades. Know your broker’s policies. Many brokerages allow foreign exchange (Forex) arbitrage but do not permit latency arbitrage. Latency arbitrage is a strategy that exploits small delays in price information dissemination between different brokers and exchanges. High frequency trading (HFT) platforms are required to take advantage of these millisecond time lags. Brokerages shy away from latency arbitrage because of technology system stress and liquidity strain.

Regulatory Requirements – Brokers must comply with differing markets and jurisdictions. These oscillating regulatory landscapes can adversely affect an arbitrage strategy, if unknown and/or unfollowed. Brokerage and trading compliance is the foundation of a successful strategy.

Do brokers allow arbitrage? Brokers allow and encourage arbitrage trading under certain conditions. Arbitrage activity is profitable for the brokerage and can be for investors, as well.

Is Arbitrage Illegal in the US?

No, arbitrage is not illegal in the US. Arbitrage legality depends on the chosen market and the specific methods and practices employed. The concept of arbitrage is a legal strategy provided it is not in violation of brokerage policies and procedures.

Arbitrage market manipulation is illegal and the activities of intentionally spreading false information to affect market prices or wash trading are forbidden. Wash trading is the act of buying and selling the same asset several times at different intervals to create the appearance of high demand. Trading on non-public information, insider trading, is an illegal arbitrage activity, as well. The aforementioned latency arbitrage is not illegal but is controversial and has gained increased regulatory scrutiny.

Is Arbitrage allowed in forex?

Yes, arbitrage is allowed in Forex. This common strategy seeks to profit from pricing discrepancies between two or more currency pairs across differing markets.  The different types of Forex trades are simple, triangular, and latency arbitrage.

All require multiple broker and market access, HFT platforms, an emphasis on risk management, and brokerage and regulatory compliance. Forex is subject to broker commissions, exchange fees, currency conversion costs, and interest payments if a margin account is used for trade execution.

Do brokers allow arbitrage? Most brokers allow arbitrage provided the strategy is executed within the regulatory framework and adheres to brokerage policies.