How to Achieve Stable Profits in the Forex Market? A Comprehensive Analysis of the Risks and Rewards of Arbitrage Trading

TradingKey - In March 2025, the Federal Reserve announced for the second consecutive time that it would maintain interest rates, while hinting at potentially two rate cuts of 25 basis points each before the end of the year.

At the same time, the Governor of the Bank of Japan indicated that if inflation continues to rise and pushes wages higher, the possibility of gradually raising policy interest rates cannot be ignored.

Adjustments in interest rates by central banks directly affect trends in the forex market. For example, when the Federal Reserve or the Bank of Japan signals a possible change in interest rates, expectations regarding interest rate differentials between USD and JPY will change. This alteration often triggers significant fluctuations in exchange rates.

Suppose you can anticipate policy directions ahead of time and adjust your positions before market reactions occur. In that case, you may be able to secure a favorable position before price movements begin, thus achieving decent profits.

Mastering strategies like arbitrage trading not only helps you capture stable gains from interest rate differentials but also allows you to position yourself advantageously amid currency fluctuations.

Don’t think that “low-risk arbitrage” is only a game for institutions—if you’re willing to learn, you can use these methods to enhance your trading performance.

1. Carry Trade

Can you imagine making a profit just by exploiting the differences in interest rates between different countries?

This is the basic concept of carry trade:

borrow a low-interest currency, like the Swiss franc (interest rate of 0.25%), and then buy a high-interest currency, like the New Zealand dollar (interest rate of 3%), earning profits from the interest rate differential.

If you perform this operation for a year, theoretically, you could achieve an annualized return of around 2.75%.

But don’t get too excited too soon.

Exchange rate fluctuations could easily eat into your profits.

If the NZD/CHF exchange rate drops by 3% while you've only earned 2.75% in interest differential, the final result is a net loss. Therefore, this type of trade is not risk-free; it requires constant monitoring of exchange rate trends to manage risk.

2. Cross-Market Arbitrage

The global forex market is vast and decentralized, and there may be temporary price discrepancies between different exchanges—this is where cross-market arbitrage opportunities lie.

For instance, if GBP/USD quotes at 1.3600 in New York while London quotes it at 1.3605 simultaneously, capturing this price difference allows you to buy pounds in New York and sell them in London, earning $0.0005 per pound.

Sounds small? But what if you're trading several million pounds? The profit becomes quite substantial.

However, these opportunities are fleeting. You need quick access to information and an efficient trading system to truly capitalize on them.

Otherwise, by the time you react, the price difference may have already vanished.

(Source: Freepik)

3. Triangle Arbitrage

Do you think there are arbitrage opportunities only with two currencies? Imbalances can exist among three currencies as well; this allows you to "go around and make money."

For example, if EUR/USD is 1.17 and USD/JPY is 146.00, EUR/JPY should theoretically be 170.82. But if EUR/JPY quotes at 170.00 in the market instead, there’s room for arbitrage.

You could start with €1 million:

Convert it to $1.17 million (€1 million multiplied by 1.17).

Convert that into ¥178.2 million ($1.17 million × 146)

Finally convert back to euros to get €1.0048 million (¥178,200,000 ÷ 170)

After going around this circle, you've made an additional €4,800 profit.

However, this strategy demands very high execution speed and calculation accuracy.

Such currency misalignments often exist for only extremely short time windows—if you're any slower at all, you'll miss out on the opportunity.

Moreover, consider trading costs and slippage; otherwise, your apparent profits could quickly evaporate.

Many people might think that the term “arbitrage” implies a risk-free money-making opportunity.

However, in reality, every trade carries risk, especially in the highly volatile battlefield of the forex market. Underneath seemingly low-risk arbitrage strategies lie numerous risks that you might not be aware of.

So what potential issues do these strategies have? Can they allow you to earn profits effortlessly while you relax?

Let’s take a look.

1. Exchange Rate Fluctuations

Although the core logic of many arbitrage trades is to profit from interest rate differentials—like borrowing yen to buy Australian dollars and earning the interest spread—it’s not that simple in reality.

If a high-yield currency suddenly depreciates sharply, not only will you miss out on earning the interest differential, but you may also end up losing your entire investment.

In cross-market or triangular arbitrage, you could face similar situations—just when you see a price difference and prepare to execute a trade, the price fluctuates instantly before your transaction can be completed. The opportunity may vanish entirely, or worse yet, you may be forced to close at a worse price and incur direct losses.

2. Changes in Interest Rate Policies

Central banks act like "commanders" of the market and can change their course at any time.

If you're engaged in carry trading and a high-interest country suddenly cuts its rates or a low-interest country unexpectedly raises its rates, the attractive interest differential may shrink rapidly.

For example, if you're earning 2.5% per year by borrowing yen to purchase New Zealand dollars but then the Reserve Bank of New Zealand unexpectedly lowers rates while Japan tightens its monetary policy…not only will you fail to profit; you could also face losses.

Therefore, carry trading isn’t just about looking at current interest rates; it’s essential to closely monitor central bank policy trends. After all, interest rates are not set in stone and can change at any moment.

3. Transaction Costs

Don't forget that trading is not free. Every currency exchange and entry into a position comes with costs.

In cross-market and triangular arbitrage scenarios, you'll need to perform multiple exchanges and transactions, which add up transaction costs significantly.

You might think you've seized upon a price difference of $0.001; however, after accounting for fees and spreads, your profits may have been completely swallowed up.

Especially when trading frequently, these costs can accumulate gradually like ants moving house—bit by bit taking money out of your account.

Thus, before executing an arbitrage strategy, be sure to calculate: Are your earnings real profits or just numbers on paper?

(Source: Freepik)

4. Liquidity Risk

In a normal market environment, arbitrage opportunities appear quickly and disappear just as fast. However, when significant news, political events, or economic crises occur, the entire market can become a situation where “no one is taking orders.”

At this point, trying to enter or exit the market becomes exceptionally difficult. Bid-ask spreads widen, execution is delayed, and in some cases, trading may be completely impossible.

Imagine seeing a promising arbitrage opportunity only to find that after placing your order, it doesn't execute for half a day. By the time you finally get to trade, the market has reversed, and what was a potential small profit has turned into an actual loss.

This is the stark reality of liquidity risk: it's not that you misjudged the direction; rather, you simply couldn't execute in time.

Of course it does.

Despite the risks mentioned above, arbitrage trading still has unique advantages that make it attractive to many investors.

1. Stable Interest Income and Potential Appreciation

During periods when exchange rates are relatively stable, carry trading can provide consistent interest income. This is very appealing for those seeking steady returns.

Moreover, if you make the right choices with your funding currency (like yen), it could also appreciate further, amplifying your gains. This isn't about lucky breaks; it's about achieving dual profits through strategic positioning.

2. Multi-Currency Diversification to Spread Risk

Arbitrage trading typically involves multiple currency pairs, meaning you can engage with various market trends simultaneously while avoiding systemic risks associated with betting on a single currency.

Especially during turbulent stock markets or uncertain global economic conditions, this low-correlation trading approach often provides more stable returns.

In other words, while others may be losing money, you could quietly be profiting.