Market Trading Strategy: Arbitrage Versus Speculation

Arbitrage and speculation are two different types of market trading strategies deployed by different set of investors. 

Arbitrage is a strategy that traders use to make a profit from purchasing financial security such as stocks or bonds in one market and selling it for a slightly higher price in another. It involves taking advantage of price differentiation in two markets.

The traders are referred to as arbitrageurs who undertake risk-free trades across global markets. 

Arbitrage generally involves making several transactions and using a large sum of money to gain a meaningful return. Arbitrage is not suitable for individual investors considering the price differentiation is quite small and most opportunities for arbitrage disappear quickly. 

Institutional investors such as banks, hedge funds and mutual funds adopt arbitrage trading strategies. 

Speculation strategy involves making the most of the investments in stocks from small fluctuations in the market. Speculation strategy is undertaken by trading instruments such as stocks, bonds, currency, commodities, and derivatives.  Speculators tend to earn profit by guessing how the market might be moving in the future. In short, it involves making money from expected volatility in the stock market. 

The speculation strategy does not require a sizeable investment base and is common among small investors. However, speculators tend to take higher levels of risk. The risk of loss and profit is far greater in speculation. 

The major differences between arbitrage and speculative strategies are the size of the trade, time duration, risk factor and structure.