Arbitrage Demystified

Fancy and successful investors such as Berkshire Hathaway's (NYSE: BRKa) (NYSE: BRKb) Warren Buffett have engaged in arbitrage to help boost their returns. But perhaps unwittingly, you may have done the same -- maybe when you bought and sold some comic books on eBay (Nasdaq: EBAY) or Amazon.com (Nasdaq: AMZN).

Arbitrage is the practice of profiting from short-term differences in price. Imagine that you can buy stock in Rent-to-Own Underwear Inc. (ticker: EWWW) for $25 per share -- in the United States. Meanwhile, you see that it's currently selling for $25.50 per share in England. If you simultaneously buy shares in America and sell the same number of shares in England, you've earned a profit of 50 cents per share (not counting commissions). This may not seem like much, but it adds up quickly if you're dealing with massive numbers of shares. That's why those who practice arbitrage are usually institutional investors with millions to invest.

Of course, you can engage in arbitrage on a smaller scale, if you buy a used DVD set of season one of The Sopranos for $32 and then sell it for $40. (Do that 124,999 more times, and you'll make a million!)

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