Triangular Arbitrage

Triangular arbitrage is the practice of exploiting a pricing inconsistency between three related currency pairs. If EUR/USD, GBP/USD and EUR/GBP are quoted in a way that the cross rate implied by the first two differs from the directly quoted cross, a trader could in theory convert through all three legs and end up with more of the starting currency than they began with. In practice these gaps are tiny and disappear in milliseconds, because automated systems at banks and liquidity providers constantly police them — this is one reason quoted cross rates stay close to their synthetic values. For retail traders, spreads, commissions and execution delays usually exceed the discrepancy, so triangular arbitrage is best understood as a pricing mechanism rather than a strategy.