There are several ways crypto arbitrageurs can profit off of market inefficiencies. Some of them are:
- Cross-exchange arbitrage: This is the basic form of arbitrage trading where a trader tries to generate profit by buying crypto on one exchange and selling it on another exchange.
- Spatial arbitrage: This is another form of cross-exchange arbitrage trading. The only difference is that the exchanges are located in different regions. For example, you could capitalize on the difference in the demand and supply of bitcoin in America and South Korea using the spatial arbitrage method.
- Triangular arbitrage: This is the process of moving funds between three or more digital assets on a single exchange to capitalize on the price discrepancy of one or two cryptocurrencies. For example, a trader can create a trading loop that starts with bitcoin and ends with bitcoin.
A trader could exchange bitcoin for ether, then trade the ether for Cardano’s ADA token and, lastly, convert the ADA back to bitcoin. In this example, the trader moved their fund between three crypto trading pairs – BTC/ETH → ETH/ADA → ADA/BTC. If there are discrepancies in any of the prices of the three crypto trading pairs, the trader will end up with more bitcoin than they had at the beginning of the trade. Here, all the transactions are executed on one exchange. Therefore, the trader does not need to withdraw or deposit funds across multiple exchanges.
- Decentralized arbitrage: This arbitrage opportunity is common on decentralized exchanges or automated market makers (AMMs), which discover the price of crypto trading pairs with the help of automated and decentralized programs called smart contracts. If the prices of crypto trading pairs are significantly different from their spot prices on centralized exchanges, arbitrage traders can swoop in and execute cross-exchange trades involving the decentralized exchange and a centralized exchange.
- Statistical arbitrage: This combines econometric, statistical and computational techniques to execute arbitrage trades at scale. Traders that use this method often rely on mathematical models and trading bots to execute high-frequency arbitrage trades and maximize profit. Trading bots are automated trading mechanisms that execute a high volume of trades at record time based on predefined trading strategies.
A divergence occurs when the RSI moves in the opposite direction of the price. A bullish divergence occurs when the RSI makes a higher low while the price sets a lower low. This is generally a strong indication that a price bounce is coming. A bearish divergence occurs when the RSI sets a lower high while the price sets a higher high and suggests the buying momentum is nearing its climax.
Using Volume in a Strategy
- Confirmation of Trends. In an uptrend, increasing volume during price advances is considered a positive sign and vice versa.
- Reversal Signals. Sudden spikes in volume can signal potential trend reversals. A sharpe increase in volume after a prolonged downtrend may suggest that a reversal could be coming.
- Breakout Confirmation. If price breaks through a key resistance level with high volume, it may indicate a more sustainable and significant move
- Divergence Analysis. Analyzing the relationship between price movements and volume can help identify divergence. For instance, if the price is making new highs, but the volume is decreasing, it may indicate weakening momentum.
- Climax Volume. Extremely high volume often referred to as “climax volume”, can signal the end of a trend
Ernie Chans Momentum Strategy Notes