You may have come across the term ‘binary options trading,’ but what exactly does it mean, how does it work, and what are the risks involved?
A binary option is a type of financial instrument: it reduces every single trade into a simple yes or no question in terms of whether you think the market is likely to be above a specific price at a certain time: you’re effectively betting either to the affirmative or the negative. If you think the price will be above this point, you buy; if you think it won’t be, then you sell. The name ‘binary’ is because there are only two possible outcomes of each trade: you will either make a pre-defined profit, or you lose the money you paid to open the trade.
It’s critical to understand that binary options contracts represent a bet on the market itself rather than buying a share in the underlying market. The price of a binary option contract is always between $0 – and $100.
Many traders like the clearly defined risk/reward outcomes of binary options trading, finding it to be both controlled yet still an exciting way to engage with the markets.
How Does Binary Options Trading Work?
Binary options contracts can be taken to speculate on four markets: forex (foreign exchange), stock indices, commodities, and events, and contracts are available twenty-four hours a day.
There are three key components to every binary options contract:
- The underlying market: this will be one of the four listed above.
- The strike price: this represents the price level that a trader will be betting on.
- The expiration date and time: the duration time can be as short as five minutes or as long as a week.
To trade in binary options, you need to ask yourself whether you think a particular market will be above a certain price at a certain time – if yes, you buy and if no, you sell. Every binary options contract costs up to $100, and every contract will state how much profit you could make and how much you stand to lose if you bet the wrong way.
Successful trades make $100, so your profit would be $100 minus whatever you paid for that particular binary options contract. When a trade is unsuccessful, you lose your initial capital but nothing else, so the risk is limited and pre-defined, which is one of the reasons that this type of trading is so popular, especially among those new to the money markets.
Traders have the option to exit the market early if they wish to by placing another order to close the position. This will serve to limit losses while protecting any profits made from the original contract.
So, to sum up, to trade in binary options, you need to:
- Gain an awareness of market trends
- Select the market you want to trade in
- Select the strike price and expiration
- Place the trade
- Wait for the expiration point – or close your position early
Advantages of Trading in Binary Options
As well as being fast-paced and exciting, the fixed risk is an attractive proposition to traders of all levels of experience.
The market direction doesn’t matter when it comes to binary options contracts – there’s the potential to make a profit no matter what direction the market is trending at any given point.
The simplicity of the speculation – a simple yes or no question – is another reason that binary options are so popular. For new traders, they can be a good introduction to the markets, as they’re easy to understand, and the risk/reward potential of each position is very clear.
Being able to close a trade early if you wish to is another key advantage of this type of trading, allowing traders to limit losses or lock in any profits made. Plus, the payouts on profits tend to be rapid: traders can expect to see their return within hours – sometimes even minutes, which is much quicker than you could expect from other types of trading.
Downsides of Binary Options Trading
Although some brokers now offer practice demo accounts specifically relating to binary options, this is not yet a widespread practice, and so, unlike other trading instruments, you may find yourself with limited options to practice binary options trading if you’re new to it.
It’s also worth noting that binary options are often more expensive to trade in than forex positions and generally offer lower payouts – although the reduced comparative risk reflects this and should be taken into account.
Be aware, too, that, while in the US, binary options contracts are usually offered on platforms that are fully regulated by the relevant financial authorities, in other territories, the binary options markets may not be subject to the same stringent set of regulations – check this carefully in order to protect your investment and reduce the risk of falling victim to a scam broker.
Tips for Successful Binary Options Trading
It’s important to learn as much as you can about this type of trading and the market you will be speculating in before taking out a binary options contract. It’s vital to be absolutely clear regarding risk and how this instrument works in practice. Making a trading plan is essential – see more on this below.
The ability to manage your own risk is fundamental to all types of market trading – self-discipline is a key element of this.
How to Make a Trading Plan
Most traders consider having a trading plan before taking any positions as vital.
Start by getting really clear about your reasons for trading: is it because you’d like to create a nest egg for retirement, or are you dreaming about a big holiday or a new house? Being honest about your motivations is crucial.
Next, set your overall goal. What is the figure, realistically, you’d like to make? Then break this down into smaller monthly targets – this is a helpful way to check how realistic your goal is and to monitor your progress. The next part of your trading plan should detail how you’re going to manage risk; for example, you should set a daily loss limit and be clear about the total amount of your capital that you’re prepared to risk in the venture – generally, traders never risk more than 2-3% of their capital per trade.
Finally, you need to plan out what you expect your trading routine to look like. Will you be trading every day? How many hours a day, and how will it fit into your lifestyle and other commitments?
Figuring out all these things in advance can help you manage your risk, stay in control of your market speculation, and keep you motivated.
What are the Risks of Binary Options Trading?
Aside from the risk of losing your capital in a binary options trade, the main risk concerns getting caught up in a scam.
Unfortunately, binary options scams are prevalent, and many people, including experienced traders, have lost a substantial amount of money to fraudsters. Unsuspecting individuals can be drawn into such a scam either by responding to a legitimate-looking advertisement on the internet or social media or, in many cases, the fraudsters will cold-call, making a credible-sounding investment proposition and usually purporting to be a reputable broker.
The trader will then usually be pointed towards a website that offers a legit-looking trading platform and seems genuine, where they are told that they’ll be able to take out the spectacularly profitable binary options contracts they’ve been told about.
Now comes the main part of the scam: unknown to the trader, the platform isn’t all that it seems. In some cases, it’s a total front. The odds are weighted wildly against the trader; they may occasionally see a small profit, and where this is the case, this has often been orchestrated to preserve the illusion of credibility on the part of the scam site.
In most cases, the unfair nature of the platform means that the trader’s balance will inevitably dwindle to zero; where individuals become suspicious and try to withdraw their remaining investment, they will typically find that they are unable to – they may discover that their trading account is frozen, and they are unable to make contact with any representatives from the organization.
In addition to this, the personal information that a trader may be persuaded to give a scammer could be used to commit identity theft, access the trader’s bank accounts, or for money laundering purposes.
What To Do If You’ve Been Scammed?
If you think you’ve been the victim of a binary options scam, then there may be recourse available that will allow you to get back your lost investment.
Your best option is to get in touch with a reputable firm of financial fraud recovery specialists, like Worldwide Recovery, which has the expertise and experience necessary to track down your money and get it back into your account. Make contact today to start the process of reclaiming your scammed money.
