Arbitrage is a process where prices of a security are exploited by buying or selling them simultaneously at different platforms. During an arbitrage, a trader buys a security in one market and sells it in another at a higher price, thus making a profit due to differences in pricing of the two different markets. An arbitrage only arises when the price of the security is different in both the markets. Theoretically, there isn’t much risk involved in arbitrage as it only consists of buying and selling of securities.
For example, the price of a security at the Bombay Stock Exchange (BSE) is Rs. 15 per share and the price of the same security at the National Stock Exchange (NSE) is Rs. 17 per share. Here, the trader would buy the security at the BSE and sell it at the NSE making a profit of Rs. 2 per share.
Arbitrage may not necessarily be profitable for individual investors as trading and brokerage fees are involved which takes up most of the profits that are to be made from an arbitrage trade.
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