Introduction
Before understanding the difference between arbitrage and trading, let us revise their basic definition.
What is arbitrage
Arbitrage is defined as the simultaneous buying and selling of the same item in multiple marketplaces, in order to profit from small price differentiation. It takes advantage of short-term price fluctuations in same or comparable financial products in different marketplaces or formats.
Arbitrage is a scenario, when an asset is purchased from one market and sold off in the other market in a small span of time. This provides an opportunity to make a profit in a case when there is a difference in price for the same asset in the 2 markets.
In the Indian stock market, there are 2 stock exchanges: National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). If you observe closely, the price of a same stock in NSE and BSE will have a small difference.
What is trading
Trading is defined as buying and selling of assets in a market,taking advantages of the daily price fluctuation. In contrast to investing, which is based on a buy-and-hold approach, trading entails into active participation in the financial markets.
Here are 7 Difference Between Arbitrage And Trading
Type of markets where the activities happen
The major difference between arbitrage and trading is the type of market in which these activities take place. Arbitrage opportunities are created by finding a small price difference of an asset in two different markets. On the other hand, trading is taking opportunity of the price fluctuation of the assets in the same market.
Considering the 2 stock exchanges (NSE and BSE), daily millions of transactions take place. Because the market participants at the NSE and the BSE are different, demand and supply will follow different paths.
The price of a particular stock trading on NSE will have a slight different value than BSE. Due to the advancement in technology, these differences are in decimals.
In a longer course of time, these figures will match, but small duration of time these difference will be present, giving chance for arbitrage opportunities.
Trading, on the other hand, is taking advantage of the price fluctuation of prices in a same markets. The stocks move in a zig-zag pattern. Thus, trading is taking opportunity to make money with the price difference in the same market.
Use of artificial intelligence
In the times of technology, where the trading takes place on a digital platform, all the data is available on real time. Hence, it is practically impossible for a human eye to capture arbitrage opportunities in the stock market. Thus, many institutes have developed tools and software to find these opportunities and execute the trade.
While, trading is a skill based activity, which still requires human involvement for best results. It can still made possible using software and codes, but still today these activities are more controlled in a more by humans.
Opportunity vs trend
Arbitrage is an opportunity seeking activity. Hence, its primary goal is to search for the price difference in the multiple markets and execute the trades. The aim to make best returns using arbitrage is to constantly look for price difference for the same asset in multiple stock exchanges.
Trading is a trend based activity. Thus, it takes the aid of technical analysis, where the trend is studied and the trade is executed. The advantage is to take the gain due to the price fluctuation in the same market.
These fluctuations are usually follow a particular price pattern, which can be thoroughly analyzed and taken informed decisions.
Difference in terms of risk involved
Since arbitrage is simultaneously buying and selling of assets in the different markets, makes it practically risk free. The low risk provides it a great advantage to execute the trades using artificial intelligence.
While, trading activities usually come with a substantial risk. Thus, it usually requires a risk mitigation strategy to manage the risk. Mismanagement of risk analysis in trading can lead to huge losses.
Capital requirement
The price difference available for executing arbitrage opportunities is usually in decimal places. Thus, in order to make a sizable profits from your trades, one requires a large sum of capital. When the large quantities of shares are brought and sold with the price difference, the profits gained can be tangible.
On the other hand, one does not require a high capital to start off trading. One can still commence trading with a small capital and make good returns out of it.
In terms of returns earned
As the capital requirement for seeking arbitrage is very high, the return on investment generated from these opportunities is substantially low. Therefore, one can expect an annual return of 5-7% using arbitrage.
Trading can provide a high rate of return if the trades are executed with a proper study and analysis.
If trades are executed with correct study and analysis, trading may yield a high rate of return. These returns generates from trading is dynamic. Its depends on the skills and experience of a trader.
More risk free investment alternatives: What Is The Advantage Of Investing In A Zero Coupon Bond
Availability of execution
Arbitrage requires a high amount of capital and complex tools and software. Thus, it is not common for a retail investor / trader to participate in the seeking arbitrage opportunities. It is usually fund houses and large financial institutions that work in grabbing these moments.
If a retail investor needs to participate in seeking arbitrage opportunities, one can consider to be an indirect participant by investing in Arbitrage Mutual Fund. These mutual funds collect money from the investors and use it for the process of arbitrage.
Anyone above the age of 18 with a substantial amount of money can trade. Hence, it makes trading attractive in the retail stock market enthusiast. Thus, there is a low amount of entry barrier for anyone to start trading, making it easy to start.
Conclusion
Summary table
| Arbitrage | Trading |
|---|---|
| Seeking opportunities of price difference in multiple markers | Seeking advantage of the price fluctuation in the same market |
| It is performed by artificial intelligence | It is performed by human involvement |
| Arbitrage is based on seeking opportunity | Trading is based on understanding the trend |
| It is risk free | It contains high amount of risk |
| High capital requirement | Low capital requirement |
| Low return on investment | Higher returns |
| Executed by fund houses and financial institutions only | Executed by retail investors as well as institutions |
Also Read: Things You Need To Know About Investment And Speculation
