What is Compound Arbitrage?

Malcolm Tatum

Compound arbitrage is an investment strategy that involves the utilization of at least four different markets. The underlying purpose for employing a variety of markets is to conduct trades in a manner that provides a higher rate of return on the same or similar financial instruments across the various markets. Essentially, compound arbitrage takes the operating strategy found with simple arbitrage and makes use of the approach across a wider range of markets.

Businessman giving a thumbs-up
Businessman giving a thumbs-up

There are several advantages for the investor when it comes to making use of a compound arbitrage strategy. First, it is possible to maximize the chances for earning returns on a security that is performing very well. By acquiring those securities on more than one market, it is often possible to ride an upward trend as the wave hits each of the succeeding markets. As the trend begins to level out, it is a simple matter to sell off the shares in a given market while retaining control of the shares traded in a different market until they also begin to level.

Next, compound arbitrage makes is possible to set up a strategy that involves purchases on one market while selling securities on a different market. In order for the approach to work, all the securities will either be the same or at least similar enough to function in the same manner. This system of purchases and sales across compound markets can make it possible to exploit price differences, with the investor buying at a low price on one market and selling at a high price on a different market.

Last, the use of compound arbitrage allows the investor to be somewhat insulated from any abrupt changes that take place in one market but have little or no effect on other markets. This advantage allows the investor to have time to plan his or her next moves before the remaining markets are impacted by whatever factors caused the change in the one market. Even when circumstances become dire, having a series of trades in progress across several markets makes it much easier to minimize and loss and could possibly even be manipulated to allow a profit to still be realized.

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