Every trading platform will warn you that trading securities and CFDs is a high-risk endeavor, and losses may well exceed initial deposits. But what if I told you there was a way to trade the forex market, where yields and risks are fixed and agreed upon prior to the trade, whereas you only stand to lose the amount you stake? This is where binary options come in.
Binary options defined
When you think of binary, you think of a system of ones and zeros, win or lose, sink or swim. Well, binary options follow the same principle. These options give you a chance to predict the price movement of a currency pair, just like in traditional forex trading. However, there is a slight twist.
There is often a target price, which is called the strike price. Your role as the trader is to predict whether the price of the currency pair you’re trading will go higher than the strike price or lower. If your prediction comes true, you’ll win a fixed amount, usually a 70-90% yield. If you’re wrong, you only lose the entirety of your bet.
Types of options
The common factor in all binary options trades is they give a trader only two choices, a yes or no question if you will. To that end, there are several types of options in the market today.
- Up or down – This is the most basic binary option. It compels traders to predict whether prices will end up higher or lower than the current price at the end of the expiry period.
- Range or boundary – For this, there usually is a range of prices, from a lower price to a higher one. The trader is then tasked with predicting whether the price will end up within this range or outside it.
- Touch or no touch – For these, levels are set, which could either be above or below the current price. The trader then bets on whether prices will touch or not touch these levels during the entirety of the expiry period. If one chooses touch and prices touch these levels before the set time expires, the trade pays out at that instant. It does not matter whether prices retrace from that level – only that they touch it.
- Ladder – These resemble up or down trades, except they feature a series of progressive levels stacked either above or below the current price. Since large price moves are often required to hit these levels, payouts will usually exceed 100%. On the flip side, the opposite side of the trade will not always be offered.
Pros and cons of binary options
- The trade is fairly straightforward as you only bet on the direction of price movement. Further, it does not necessitate complex risk management procedures such as setting stop-losses.
- Risk is fixed and limited to your deposit, unlike in the currency market, where risk may vary with several factors and may exceed your initial deposit.
- Binary options offer a decent profit potential per trade, spanning 70 to 90% of the risked amount or even greater in some instances.
- In addition to currency pairs, you can trade binary options on a variety of assets such as stocks, commodities, and cryptocurrencies.
- You can trade binary options during any forex trading session, which means the market runs throughout the 24-hour day.
- To obtain a big payout, you have to set a target with reduced odds of happening, such as pushing your expiry date further into the future. If your odds of success are high, the payout tends to be minimized.
- Most brokers offer binary traders fewer analysis tools than those afforded to their other clients.
- The way these trades are set up, you stand to lose more from a misjudged trade than you would gain by winning the same trade.
- There are usually minimum deposits to enter these kinds of trades, which means the losses you incur are often substantial amounts.
How to trade binary options
1. Selecting a broker
First of all, to avoid being scammed, you’ll want to choose a regulated broker who’s licensed by a re-known regulatory body. These include Cyprus’s CySec, UK’s FCA, Australia’s ASIC, or US’s CFTC, just to mention a few. You will also want to choose a broker who offers a transparent and competitive pricing structure so that your transaction costs do not end up eating into your profits.
Most brokers will require no minimum deposit, while others will cap it at $50 or $100. You will typically be looking for one with a low minimum deposit. Further, you need to analyze their brokerage platforms to see whether their offerings and customer support are par.
2. Choose a currency pair
Just like in traditional forex trading, you will want to choose a pair that you’re familiar with. The best pair to trade with is the one you’re most informed about. This information will help you perform extensive technical and fundamental analysis, which improves your chances of success.
3. Select an expiry time
Usually, expiry times fall under three categories. There are turbo trades, which are short-term trades lasting under 5 minutes. Normal trades range anywhere from a 5-minute timeframe to the end of the trading day. The third type is the long-term timeframe, which could span up to a year in length.
4. Select your position size
The bigger your investment, the more you stand to gain in the way of profits. However, a big investment also exposes you to increased risk, as you could lose the entirety of that investment.
5. Select a binary option
This step entails choosing among the aforementioned types of binary options. You should choose the option that has higher chances of playing out as you predicted rather than going with the option that promises the most returns. After all, emotional trading can be just as detrimental to binary options as it is to conventional trading.
Binary options are a way to trade forex by betting whether or not prices will hit a certain level. When your prediction comes true, the payout usually ranges from 70 to 90% of your bet, while losses are limited to the amount you staked on the trade.