Key Takeaways
- 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.
Definition and Example of a Fungible Investment
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 US dollar for a Canadian dollar—they don’t share the same value.
In trading, fungibility implies the ability to buy or sell the same financial instrument in two or more different markets. 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.
There are many fungible financial instruments, with the most popular being stocks listed on multiple exchanges, commodities (such as gold and silver), and currencies.
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Most undifferentiated 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.
For example, if you can buy 100 shares of a stock on the Nasdaq in the US and sell the same 100 shares of that stock on the London Stock Exchange in the UK, with the net result being zero shares (100 bought and 100 sold) , then the stock is fungible.
How a Fungible Investment Works
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.” 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 per share.
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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 can be more than 300 (the number fluctuates) listed on both the Canadian and US stock markets.
The stocks on the Canadian market are listed in Canadian dollars, while the same stocks will be priced in US dollars on the US exchanges. Since stock prices constantly fluctuate, and so do exchange rates, fungible stocks are more likely to have arbitrage opportunities. Because of the exchange rates, though, spotting good opportunities requires more effort.
What It Means for Individual Investors
Suppose you find a stock that trades on the US exchange, currently with an ask price of $10 and a US dollar (USD)/Canadian dollar (CAD) exchange rate of 1.30.
If the best deal you can get is a USD/CAD rate of 1.30, then it is expected that the stock would trade at about C$13 on the Canadian exchange. ($10 US stock times 1.30 equals C$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. If traders see a large enough arbitrage opportunity to make a quick profit, they will step in. This pushes the underpriced market up (by buying) and the overpriced market down (by selling), bringing the two markets back into equilibrium.