One of the most unattractive things about forex is the fact that you can lose more than what you put into the pot. How? Because most forex traders capitalise their trading accounts with $10,000 or more, yet they only actually use 2% or less of that for trading. This means that most of the money is just sitting in their trading account doing nothing. But, they also use leverage. A trader may be leveraged 100:1, meaning that for every $1 he trades of his own money, he is controlling $100 of the brokerage’s money.
This is great as long as he continues to make money. However, if he loses, he could lose more than what he started with – including his cash reserve in savings. Binary options allow him to trade without this type of risk.
What Are Options?
Options contracts are financial contracts where you have the right, but not the obligation, to buy a specific number of shares of a particular stock for a predetermined price, within a specified time frame. Binary options are based on stock options, so it’s helpful to understand how these products work, in principle.
You are trading very exotic and complex financial products, but the mechanism that you see as the end-user, is actually very simple. You buy a contract for a particular price, and you wait to see what the market does.
You typically buy options “out of the money,” meaning that the option is worthless when you buy it. You hope that the option goes “in the money,” making it valuable. This is how you make money in options.
It’s similar to a “buy low-sell high” financial strategy with stocks. The only difference is that you can control a large number of shares of stock without actually paying to own them. The cost, in most cases, is but a very small fraction of what you would pay to own the underlying financial asset.
What Are Binary Options?
Binary options are options that you buy on the forex, commodities, or stock market indices. Binary options are simple to execute in the sense that you only need to decide on whether you think the currency pair will move up or down. In that sense, it’s more like a bet than an investment. Options are also extremely transparent.
You know all of the facts about the options contract before you buy. There are no surprises, there are no hidden fees, and you can only lose what you put into it.
Should You Do It?
Whether or not you trade binary options depends on your tolerance for the immense risk involved in them. Even though you can only lose what you put in, your forex trading system hinges on a binary “up/down” movement of the currency pair.
You’re not entering or exiting trades, so you can’t recoup losses or ride a trend. You can sometimes buy into range binaries, where you bet that prices will remain within a break out of a specific range before the option expires, but this isn’t the same thing as normal range trading.
At the end of the day, this is a simplistic way to bet on the forex market, but it does require extensive knowledge of how the market moves.
Alex Fletcher recently discovered the lure of five-minute binaries. A long time investor, he loves to share what he finds with others by writing about it. You can read his illuminating articles on many websites and blogs.