Arbitrage is the practice of buying an asset in one market and simultaneously selling it in another, but at a higher price. As a result, the transient difference in share price benefits traders and investors.

When it comes to stock markets, arbitrage trading enables traders to take advantage of chances to buy a security at a foreign exchange where the share price of the security hasn't yet been adjusted for the rate of foreign currency.

This is an attempt to make money by selling before the foreign currency rate fluctuates, and it would be difficult to do so. The price of the stock on the foreign exchange decreases in value in comparison to the local exchange as a result of profits made from the difference between the two marketplaces traded in. Although this may seem hard to a newcomer, arbitrage is actually relatively simple to grasp and is regarded as low-risk.

How does arbitrage works – An illustration

Tata Motors is traded on both the New York Stock Exchange and the National Stock Exchange. On the NYSE, the price of Tata Motors is quoted in US dollars, while the NSE quotes the same price in Indian rupees.

For instance, in case Tata Motors trades at $4 per share on the NYSE. The share price is Rs 238 on the NSE. The share price of TATA Motors on the NYSE in INR will now be Rs 240 if the USD/INR exchange rate is Rs 80. In this case, when converted from USD to INR, the same stock is listed at Rs 238 on the NSE and Rs 240 on the NYSE.

A trader will purchase shares of Tata Motors at Rs 238 per share on the NSE and sell the same number of shares for Rs 240 on the NYSE to take advantage of the arbitrage opportunity, making Rs 2 per share in profit.