Arbitrage is the practice of taking advantage of a price difference between two or more markets or exchanges. In Indian markets stocks are traded in two major exchanges – NSE (National Stock Exchange) and BSE (Bombay Stock Exchange), which means you can take advantage of buying the stock in one exchange and selling it in other and bag the difference as profit.
We have few points to consider before doing an arbitrage trades.
1. Arbitrage is not An Intraday Trade (Cost Wise)
You are not allowed to buy and sell the same stock in different exchanges on the same day. This means if you buy stock XYZ today in NSE, then you are not allowed to sell stock XYZ in BSE the same day. If you do that, you may have penalty of short selling in the exchange you sold.
It means you can only do arbitrage for stocks that you have in your DP. If you have stock XYZ in your DP, you can sell the same in BSE and buy them in NSE as well to bag a profit but then you are not doing intraday trading and so you may be paying the brokerage of delivery to your broker though you are trading on the same day – time wise.
2. Last Traded Price is not the Price for Arbitrage
If you are seeing a price difference of few Rupees in both the exchanges does not always means there is an arbitrage. Take an example of Weizzmann Forex.
We see the price in BSE as 69.90 and in NSE as 74.90, which can be concluded as an arbitrage opportunity but there is no arbitrage opportunity. Let me explain to you why.
The big price number that you see is last traded price which means those price in both the exchange is the traded price and not the price at which you will be able to trade.
Your price would be either offer price or bid price. Let me explain offer price, bid price and last traded price first in simple terms.
- Offer price is the price that others are offering their shares at. So you can buy at the offer price.
- Bid price is the price that others are willing to buy shares at. So you can sell at the bid price.
- Last traded price is the price when offer price and bid price matched and the trade took place.
So if you see the offer price and bid price in both the exchanges they are
- Offer price in NSE is 74.90 for 48 shares.
- Bid price in BSE is 67.30 for 50 shares.
So if you execute the trade then your offer price should be 67.30 in BSE and Bid Price in NSE as 74.90 and that would mean you are buying high and selling low making a loss and not a profit arbitrage.
So arbitrage exists only if you have higher bid price and lower offer price in either of the exchanges.
3. Arbitrage Trades should never be Manual
As a retail investor we may be able to spot some arbitrage opportunities but if you try to key in those trades manually, the opportunity may be gone because there are so many big traders who have automated softwares running for spotting such arbitrages and execute those trades. If you think you can beat those programs spotting arbitrages, you are wrong.
On top of that you are trading with broker in between you and the exchange but large traders have direct access to exchange and so they don’t have broker in between, eating their profits and so they can spot arbitrages much earlier than us. By earlier I don’t mean time early but price early.
It does not mean that retail investor cannot trade in arbitrage and circuits are best opportunities for arbitrage where if you have stock in your DP and if it hits circuit in both the exchange, you can opt to buy in circuit where the pricing is low and once the buy is executed, you can sell your stock from DP in exchange where pricing is higher than you just purchased. I did the same in Fame India here quite some time back.
Avoid spotting arbitrage in low volume stocks because pair trade execution can be tough in them. If you have any question about arbitrage, you can ask them in comments below.