Show HN: Statistical Arbitrage on Stocks Explained
quantopian.comPairs trading/hedging is not "arbitrage." It's a risk-mitigating strategy.
An arbitrage strategy would be a strategy that would be guaranteed to make money. (And would probably not be shown on a blog post)
Indeed, arbitrage means guaranteed money, usually by exploiting different prices in different markets.
Imagine $AAPL trades for 100 at market 1 and for 95 at market 2. This is an arbitrage opportunity. Buy for 95 at market 2, sell for 100 at market 1. This is a gauranteed profit of 5. Obviously this would drive the price down in market 1 (excess supply) and up in market 2 (excess demand), which would balance these 2 out eventually.
Here is an old joke about this:
Two economists walk on the road and find a $100 bill in the road. Economist 1 asks whether he should go for it. Economist 2 replies that such an opportunity cannot exist as someone else would have already taken the bill. That means either the bill is there to test some one (candid camera, honeytrap by cops, etc) or the owner would be back shortly. In either case, the $100 is not a risk-free opportunity.