Flaws in my strategy?

Discussion in 'Strategy Development' started by fxPadawan, Feb 10, 2007.

  1. Please review these arbitraging strategies and expose any flaws. The "market makers" here just convert 1 currency to another at their exchange rate. They are not forex "trading" houses per se. So I do not enter and exit with the same MM.

    Assumed required criteria:
    1) Market maker #1 "MM1" has a lower buy price for currency 1 "C1" bought with currency 2 "C2" than market maker #2 "MM2" has as their sell price for the same instrument.
    2) All accounts with banks "BA#" and market makers would be in my name.
    3) MM1 should not know that I also deal with MM2 (and/or vice versa) or they may change their prices to not have this imbalance. (Or is this impossible because my relationships will show on a credit report check?)
    4) This is not laundering because this is not illegal (or is this the very definition of laundering -- "who knows whom" and is this act illegal)?
    5) The lot size would need to be large enough to cover (wire) transfer fees "W#" and earn a profit.
    6) A bank only deals in 1 currency or their exchange rate will nullify the arbitrage opportunity (or more likely cause a loss in my profits).

    Method 1:
    No entity (BA# or MM#) "knows" more than 2 other entities:
    C1 banks do not know C2 banks and MM1 does not know MM2.
    BA1 sends W1 in C1 to buy C2 from MM1.
    MM1 sends W2 in C2 to BA2.
    BA2 sends W3 in C2 to BA3.
    BA3 sends W4 in C2 to sell to MM2 and receive C1.
    MM2 sends W5 in C1 to BA4.
    BA4 sends W6 in C1 to BA1.


    Method 2:
    Each bank "knows" both market makers and each MM knows both banks.
    But neither bank knows the other bank and neither MM knows the other MM.
    BA1 sends W1 in C1 to buy C2 from MM1.
    MM1 sends W2 in C2 to BA2.
    BA2 sends W3 in C2 to sell to MM2 and receive C1.
    MM2 sends W4 in C1 to BA1.

    I haven't done the calculations yet, but what lot size would be required to break even or profit from what difference in buy/sell prices?
     
  2. Hi fxPadawan,

    From reading your post, I guess you are doing this for personal account. Beside the wire-transfer fees you are factoring in, you will also need to factor in:


    1) Foreign currency accounts
    Your bank will need you to have foreign currency account to receive the foreign currency you buy. You must also have the other foreign currency you are selling deposited in your bank account of that currency. One account for each currency. Your bank is likely to impose a monthly fee for each foreign currency account you hold.


    2) Bank's board rates
    You will likely have to convert all the foreign curreny profits and losses back to your home currency one day. You will have to do so at the bank's board rate where the bank's buying and selling rates are as wide as elephant spread. This board rate alone will kill your strategy dead.


    Such arbitrage trades (in FX) may only be suitable if you are a bank FX trader trading for a bank. Their cost is only the cost of two SWIFT wire transfer.
     
  3. This is naughty trading and I suggest you turn yourself into Michael Stumm.
     
  4. Thank you for your replies. What are your thoughts on my assumed requirements #3 and #4?

    Hi ChoSingKum,
    Your point 1 is my concern in my requirement 6. Method 1 has 4 separate bank accounts (2 in each currency). Method 2 has only 2 accounts (1 each in different currencies).

    Yes, I am thinking of a separate bank and account for each different currency. My search today has been to find a single bank to maintain multiple separate currencies. Due to posts I've seen (I think on EliteTrader -- when a user bought currency X and was shocked that currency X was in his account instead of his deposit currency), so I am assuming that an FX Trading account does just that (hold multiple currencies -- until a withdrawal is made in the users's deposit currency). I assume currency X was in his account when an open position existed unless he traded in pairs not including his deposit currency.

    But these FX Trading accounts tend to want to transact with only 1 bank -- the bank which opened the account in the first place. My need would be for currency conversion houses (the MM's) to also be able to deposit into the account that is able to accept multiple different currencies (perhaps like an FX Trading account). Can you recommend such a service entity (bank, trading house, etc.)?

    Actually the deposit (destination) from the MM could be to me (or any recipient I designate) using bank drafts; but I used wire transfers in the above methods for more frequent and faster transactions. (I mention this in case you see an available adjustment to my strategy here).

    The last step in both my methods is your step 2 (previously converted by MM2).


    Hi ElectricSavant,
    I have come across your helpful posts before. Now I notice you are a moderator. Who is this Michael? Google lists many. Ahh Oanda and the Toronto Professor are the same? Is this whom you mean? What is your point? I have not read this Michael.
     
  5. fxp,

    HeHe..once Michael called an arb between 2 second snapshot Oanda quotes and 200 plus partipants in E-sigs quote server..."naughty trading"...

    HotSpot FX can accomodate the "result" with what you are purposing...do not ask...FX dealers do it all of the time and take out the spread upfront...

    I am a volunteer here...

    Hi ElectricSavant,
    I have come across your helpful posts before. Now I notice you are a moderator. Who is this Michael? Google lists many. Ahh Oanda and the Toronto Professor are the same? Is this whom you mean? What is your point? I have not read this Michael.
     
  6. Anyway, if my calculations are correct, even Method 2 with only 4 wires totalling $60 with a 1 pip (0.0001) arb opportunity, would require a lot size of $600,000 to break even. I don't see any concept of margin (except 1:1) for conversion houses.

    Would this be a correct calculation?
     
  7. Before we start drawing fancy trade flow diagrams with circles and arrows, let's step back and take in the big picture. Your "assumed required" criterion #1 for the arb is, simply put, a crossed quote: one market maker's ask < another market maker's bid.

    Ignoring everything else for the time being... in the real world of foreign exchange, how often do you expect to observe criterion #1 being met, in an actionable way, and for how long?
     
  8. Hi fxPadawan,

    Where I live, I won't be able to do what you are thinking of. The total costs far far outweight any arbitarge gains in retail currency prices, if any. And there is probably none.

    Any issuance of bank draft in any currency from anywhere will also certainly involve bank fees to be absorbed by you so not really much difference from wire-transfer.

    Furthermore, before you can even begin, you must already have the foreign currency you want to sell in your account. If you do not then you cannot even proceed to do anything.

    Arbitrage opportunity only occur when prices from different sources do not move in line and this is only very brief, probably seconds. If prices stay out of line for long then there may be other reasons, may be some sort of restriction or something which in the end cannot be arbitraged.

    I am not able to recommend any banks or houses.