Understanding arbitrage can be complicated. Especially because when people talk about arbitrage they can be talking about it in a variety of different contexts. Let’s examine arbitrage in the context of the stock market. The process of calculating the arbitrage is when a day trader finds a price discrepancy in the market that allows them to buy a stock at one price and quickly sell it again for a higher price thus making a profit off of the stock they have held onto for very little time. This can happen in a variety of situations, such as the merger of two companies together, or perhaps a day trader may purchase a stock on a foreign stock exchange that has not yet adjusted to the price that it will be according to the current exchange rate.
Working as a day trader that calculates arbitrage is a quick moving business. They have to quickly understand that a stock has been underpriced and snatch it up, and then they have to turn around and quickly sell it at the higher price before the market readjusts itself. If the stock market where a perfectly working machine that never made any errors, then there would never be an opportunity to work as an arbitrage service, because all prices would always be correct. However, we do not live in a perfect world, therefore many day traders make a big chunk of their income from these kinds of transactions.
If a person working the stock exchange does not move quickly to unload a stock before the stock market rebalances, then they will not make a profit. That is why it is so important to move quickly. A great example of this is the process of buying and selling goods online. Let’s say that your local Target is selling a particular item for half the price that you can buy on Amazon. You go and buy all of that item up at target and then sell it on Amazon for the same price that all of the other items are being sold for and in the process you will make a profit off of it. Eventually target my realize that they are underpricing their product and raise the Price of their item to match the Amazon price, but in the meantime you have made a small bit of money. This is how arbitrage works.
In the context of the stock market, many investors will immediately reinvest their profits back into the stock market. Sometimes they will get an arbitrage rebate if their profits come in and above the amount that the bond can yield. This gets a little bit more tricky and that is when an arbitrage service can come in and help calculate the proper rebate A investor should be receiving. For savvy day traders, arbitrage is a great way to make money. It does not always work out in their favor, but more often than not they end up with a profit from their quick thinking and investment.