Fungible investments can be bought and sold on multiple exchanges. When combined with fluctuations in currency exchange rates, they can present an opportunity for investors to make a significant profit.
In simplest terms, fungible securities allow investors and speculators to buy low and sell high to make a profit. This works through a process known as arbitrage. Learn more about buying and selling across different markets can work to your advantage.
What Is a Fungible Investment?
A financial instrument (such as a stock, bond, or futures contract) is considered fungible if it can be bought or sold on one market or exchange, and then sold or bought on another market or exchange.
In a broader sense, fungibility is the ability to substitute one unit of a financial instrument for another unit of the same financial instrument. This works with paper money when you swap your dollar for someone else's. It doesn't work if you try to trade a U.S. dollar for a Canadian dollar—they don't share the same value.
There are many fungible financial instruments, with the most popular being stocks listed on multiple exchanges, commodities (such as gold and silver), and currencies.
Most physical assets are considered fungible because you can buy or sell them at various places. For instance, you can buy gold or silver at one dealer and sell it to another dealer.
In trading, fungibility implies the ability to buy or sell the same financial instrument in two or more different markets. For example, if you can buy 100 shares of a stock on the Nasdaq in the U.S. and sell the same 100 shares of that stock on the London Stock Exchange in the U.K., with the result being zero shares (100 bought and 100 sold), the stock is fungible.
How Making Money With Fungible Investments Works
Fungible financial instruments are often used in arbitrage trades. In arbitrage, a trader takes advantage of a price difference in two different markets, buying at a lower price in one market and selling at a higher price in the other market.
For example, consider a stock that's listed on both the Austrian and German stock markets. One market has the shares trading at 6.23 and the other has them trading at 6.27 (both priced in euros). A trader can buy the shares at 6.23 on the one exchange, and sell them at 6.27 on the other, netting 0.04 euro on each share.
Arbitrage trades are more likely to occur when a currency exchange rate is involved, as traders can spot arbitrage opportunities in the same currency very quickly. As a result, these opportunities don't last very long.
It becomes more complex when a stock or other asset is priced in different currencies on each exchange. For example, there are often about 200 companies (the number fluctuates) listed on both the Canadian and U.S. stock markets.
The stocks on the Canadian market are listed in Canadian dollars, while the same stock will be priced in U.S. dollars on the U.S. exchange. Since stock prices constantly fluctuate, and so do exchange rates, fungible stocks like this are more likely to have arbitrage opportunities. Because of the exchange rates, though, it requires more effort to spot good opportunities.
Say you find a stock that trades on the U.S. exchange, currently with an ask price of $10 and a USD/CAD exchange rate of 1.30. The example assumes this is the price at which an arbitrage trader can exchange capital, which is typically a much better exchange rate than a retail trader can get from their bank.
If the best deal a trader can get is a USD/CAD rate of 1.3, then it is expected that the stock should trade at about CA$13 on the Canadian exchange ($10 U.S. stock times 1.30 USD/CAD equals CA$13).
From second to second, there may be small discrepancies, as the currency rate changes and the stock is subject to its own price changes from buying and selling pressures. But if traders see a large enough arbitrage opportunity to make a quick profit, they will step in. This pushes the under-priced market up (by buying) and the over-priced market down (by selling), bringing the two markets back into equilibrium.
- Fungible investments can be bought and sold on different exchanges.
- Fungible trading works when you can buy/sell on one exchange, and sell/buy on another exchange, netting your share position to zero and earning a profit.
- Opportunities to profit from price differences are known as arbitrage, and they come and go quickly as the markets and exchange rates move.