Using Risk Parity

Risk parity in foreign exchange results when there is no price differential in trading. This state of affairs greatly reduces or omits totally any opportunities of arbitrage profits in forex strategy. It still allows for profits to be made by long term investors, however.

Those seeking to profit from arbitrage trades capitalize on inefficiencies in the market. An opportunity for an arbitrage profit results when a foreign currency unit is selling at different prices in different exchanges. To profit, a buyer will quickly buy the foreign currency in one market at a lower price, and then sell it in another at a higher price. The price differential is booked as profit.

The condition of risk parity is based on capital mobility and perfect information in the foreign exchange markets, as with all others. For capital mobility, there is present the means that funds will seek the most effective methods to profit from the most efficient usage. The advanced technology of today guarantees that this element remains a constant and is also continually being improved.

That too is almost the case for perfect information. This element of the efficient market schools of thought is that all available information has been accurately factored in the price of an asset, which minimizes trades based on a flaw in the system. If that were true, however, there would be no school of value investing that has resulted making Warren Buffett, its most prominent practitioner, worth over $50 billion and considered by many to be the best ever.

What accepting risk parity allows for is the opportunity for those who buy and sell in a forex strategy to profit like Warren Buffett, from long term movements in the price, hopefully upwards. Buffett has noted that Newton’s Fourth Law should be the greater the movements of a speculator, trader or investor, the lesser the returns. As Buffett has often stated about his holding period, “Long term is forever.”

That is the opposite of an arbitrage forex strategy, which seeks to profit from market inefficiency in the pricing of a like asset. As Benjamin Graham, the founder of the value school of investing and inspiration for Warren Buffett has noted, speculators seek to profit from the conditions of the market. Investors seek to profit from the condition of the asset.

Arbitrage is pure speculation as risk parity is long term investing.

Profits are hoped for from a forex strategy based on the inefficient pricing of one foreign currency unit in one market as opposed to that price level for it in another. The last thing the punter wants to happen is to be caught in a position that results in a long term holding in foreign currency that was incorrectly thought to be a short term gain. Risk parity protects the long term investor who minimizes trades from being caught in that painful, costly position.