I am not a finance expert at all, but I recently got this idea from a conversation with a friend on whether it is possible to make money by starting with a fixed amount of dollars and then try and keep exchanging it for other currencies and finally exchange back to dollars while turning profit.
An example should be something like this: $10 ⟶ ¥10000 ⟶ €5 ⟶ $12 (profit)
Is this possible? Is there a word for it? As a physical person, is it wise to do this as a way of investment?
I recently got this idea from ...
You're not the first. (Or the 8000th.)
Is there a word for it?
Arbitrage (pronounced in French) is "the simultaneous purchase and sale of the same asset in different markets in order to profit from tiny differences in the asset's listed price. It exploits short-lived variations in the price of identical or similar financial instruments in different markets or in different forms.
Arbitrage exists as a result of market inefficiencies and it both exploits those inefficiencies and resolves them."
Sadly, no, you can't make any money off of it, because other people already have.
EDIT: "cryptocurrency" is not a Magic Word which makes trading negate the laws of economics and sociology. The answer to whether one can arbitrage cryptocurrency is the same as whether you can answer all other currencies: how inefficient (slowness in price changes reflected from market to market) the cryptocurrency markets are. I guarantee that you're not the 8000th person to try and arbitrage cryptocurrency. If there's still a difference in prices between markets, the whole cryptocurrency market is seriously broken.
An example should be something like this: $10 ⟶ ¥10000 ⟶ €5 ⟶ $12 (profit)
This is called triangular arbitrage. The concept is simple and well-known. The process is not risk-free. There are many potential execution pitfalls. Even if you manage to identify a profitable cycle, the prices could change before you manage to complete the cycle. Your example involves three trades (USD → JPY; JPY → EUR; EUR → USD). During the execution of the first trade, the prices of currency pairs in the second and third trades may move in such a way that makes the entire cycle unprofitable. For these reasons (and many others), retail investors may not be able to make any money from triangular arbitrage.
Since you appear to be a programmer, you may be interested to know that the Bellman-Ford algorithm can be used to quickly check whether or not a profitable arbitrage cycle exists, and if so, find one of the cycles. The detection of arbitrage cycles is one of the applications of shortest path algorithms, and this use is mentioned in popular algorithms textbooks such as Algorithms by Sedgewick and Wayne (see § 4.4 Shortest Paths), and Introduction to Algorithms by CLRS (see Problem 24-3 "Arbitrage").
The Bellman-Ford algorithm only finds one cycle. To get the list of all profitable cycles, a simple depth-first search (DFS) should suffice (the inefficiency of DFS may not matter if you are only involving a small number of currency pairs). This is an interesting exercise in implementing graph algorithms, but don't expect to make any money from your implementation!
One of my teachers (established engineer doing his Ph.D. in older age teaching us) at the university made a solid amount of money designing special hardware, one of the uses of which was to trade on exchanges and make money precisely the way you describe.
The problem for small players?
There are big players with:
That allows them to make these trades before your computer running your trading app even gets to authenticate to the standard API...
There are two ways to do this:
One is to find "instant" cycles of currency pairs which are not completely equivalent and result in a higher amount after conversion, as explained in the other answers.
As they state, the issue is that you're far from the first one to think about it, and the market tends to self-correct, so the window to do it is very very very short, and the gains tiny.
Also, once you factor in transaction costs, the likelihood you will actually make any money is vanishingly small unless you deal with very large volumes.
The other way is really just plain speculation: you exchange your USD for another currency which you think will appreciate against the USD, and when it does, exchange it back to USD (you don't even need a third currency in this case, though nothing prevents you from cycling through more currencies). Exactly like you would buy shares of a company the price of which you think will go up and then re-sell them once it has gone up. One of the main drivers for currency exchange variations are changes in interest rates, and lots of people play oracle trying to guess what the central bank will do.
Like stocks, this is of course quite risky, as currency exchange rates do not always go in the direction you think they will. On the other hand, there are sometimes other forces at play which make some operations possible on currencies which are not possible on stocks, as central banks can have policies that will force them to buy or sell at specific prices.
As a consumer, you will however often be hit by the large "spread" between buy and sell rates, which means that even if the exchange rate does not move at all, you'll lose money.
About the time when the Euro was introduced, one major store in the UK accepted Euro for payment (they don't do that anymore), and returned your change in pound.
Unfortunately for them, they had confused the exchange rate. Instead of say £1.00 = €1.20, they applied a rate of €1.00 = £1.20. So you took 100 euros, bought five pound worth of items, they returned £120 - £5 = £115. You kept £30, went to the bank, and changed the remaining £85 to €100. With your fresh €100 note you went back to the store and repeat.
They figured it out rather soon.
A while back there was a situation where one crypto exchange had a price per bitcoin that was quite a bit higher than all the other crypto exchanges. One could in theory sell bitcoin on that exchange, withdraw the dollars, move them to another crypto exchange, buy bitcoin, transfer the bitcoin to the original exchange and repeat. There were a couple of problems with this.
This lead to the collapse of Mt.Gox with people having significant nominal bitcoin and dollar balances left on it. If exchanges show a difference significant enough that you could make a profit there is probably a reason for it. It is not so much investment as speculation.
The name is arbitrage.
Yes, if an opportunity exists, you can do it. However, the very act of doing it will destroy the opportunity for anyone else to do it. Arbitrage has this nasty habit of causing equilibrium between markets. So you are essentially in a race with anyone else who is trying to do this as well to be the first.
It is a very hard way to make money.
