What Are Binary Options Trading? - Binary Options Explained With Example
Binary Options trading are known for their simplicity and all-or-nothing nature. Moreover, a few reasons are behind to give this trading type name binary option. Options are derivative instruments. It can be traded as forex pairs, cryptos, stocks, indices, commodities, etc.
Furthermore, for traders, it is a lucrative trading type because of it’s quick and high return percentage. But, according to the research, binary traders should pay close attention to the rules of trading before diving with real money.
So, consider this article as a guideline for beginners and hence, we will keep it as simple as possible. Let us start with the binary definition first.
What Is Binary Options Trading?
Abe Cofnas is a thought leader and analyst in the financial industry. We took a line from his book to explain the actual meaning of binary.
“The binary option is called binary because it fits the condition of being either right or wrong-all or nothing.”
On the other hand, the exotic option allows a trader to speculate on the price movements of various instruments. To trade binary option, you don’t need to purchase an underlying asset.
You rather predict whether the price will increase above, or decrease below the strike price or purchase rate. The strike price is the price, at which traders trade underlying assets. Market price must increase or decrease, by the time the trade expires.
The expiry period for binary options is very diverse. The time frame starts from 30 seconds and lasts up to a year. After prediction the price, you will select the call or put option, depending on the asset price movement.
If you guess accurately, you win a payout. But the wrong prediction will give you nothing. It is required to mention that the payout rate differs from asset to asset and broker to broker.
Speaking of assets, there are multiple trading instruments that you can trade as binary options. Before selecting any pair, find some strategies and rules on how to trade binary options.
We will explain all the terms and facts of the binary option below that will give you more knowledge to understand.
Binary Options Explanation (Video)
Binary Online Trading With Example
We will explain the most commonly used high low/ call put method of binary trading using an example.
Consider the following situation:
You are particularly interested in trading the EUR/USD pair. The broker offers a payout percentage for this asset is at 90%. The first thing that you need to determine the expiration time.
Say, you have chosen 10 minutes as the expiration period. Next, you need to predict if the market price of EUR/USD will close above or below the current purchase price. If you think the price will close above, you buy a call option. And if you think the market price will close below, you buy a put option.
It doesn’t matter how much the price has to be above or below. All you need to do to win a payout is guess accurately.
The term guess is used vaguely here. It involved technical and fundamental analysis using trading tools, indicators, and follow the market news for that underlying asset. After your market analysis, you decide to buy a call option because you think the price will rise from the strike/purchase the price, which is currently at $1.14.
You decide to invest $10 in this trade. As the payout is 90% you either earn a 90% return or get nothing in return.
Let’s examine the two scenarios.
If your prediction is correct (EUR/USD price rises above $1.14 after expiry) you get $10 + (90% of $10) which is equal to $19.
If your prediction is wrong (EUR/USD price drops below $1.14 after expiry) you get nothing in return i.e. $0.
Common Terms in Binary Options Trading
We have used a few terminologies above. Before you can trade binary options, you should know.
We have listed them here:
- Call Option
- Put Option
- Strike Price
- Expiry Date
- In The Money
- Out The Money
- Rate Of Profit
Binary – The term ‘binary’ is used because there are two possible outcomes.
Call Option – A trader chooses a call option when he predicts the price of the underlying asset will increase before the expiration period.
Put Option – When a trader predicts the asset price will decrease before the expiration period, he chooses a put option.
Strike Price – The strike price at which the put or call option can be exercised. It is also referred to as purchase price since it is the price at which you purchase the option.
Expiry Date – The time when the binary options asset expires.
In the Money – When you accurately make a prediction and win a payout, then you are ‘in the money’.
Out the Money – If you lose a binary options trade, it is referred to as “out the Money”.
At the Money – At the end of the expiry period, if the strike price matches that of the market price, is referred to as “At the Money”. In this case, you don’t win or lose anything, and your initial investment is returned to you.
Rate Of Profit – This term represents the percentage of money that you will get after winning trade.
Types Of Binary Option
There are many types of binary options available in the market. In this article, we will discuss 4 types of binary option, that are commonly used by traders, and widely offered by brokers.
You will also find other types depending on the brokers offering.
High/Low is the most common type of binary option. By accurately predicting if the market price will be less or more than the strike price at the end of the expiry period will reward you a payout.
The trader buys a call option if he thinks the price of the asset will increase from the current market value. If he thinks the price of the underlying asset will drop compared to the current market price, then he will open a put option.
In / Out or Boundary:
In this form of binary trading, traders have to predict whether the price of the asset they have chosen will stay within a given price boundary or stay out of it.
The upper and lower limits of boundary or range are determined by the broker. Furthermore, the trader selects the preferred time duration and asset.
Like high/low if the trader accurately predicts the outcome, he will get a payout. If he loses, he gains nothing and also loses his initial payment.
Touch / No Touch:
For high/low and in/out binary options, the payout is fixed. However, it is not the case for touch/no-touch options.
In no-touch binary options, the trader selects a strike price that is above or below the current market price.
After selecting the expiration time, he places the trade. To secure a payoff, the market price of the underlying asset should not coincide with or exceed the strike price, before expiry. Here, variable payouts come into play.
The closer the market price is to the strike price, the higher is the payout. Another area where no-touch options differ from high/low is the payout percentage. Payouts for high/low rarely exceed 95%.
But in the case of no-touch, traders can enjoy a payout of 200% or higher. In some cases, it exceeds even 500%.
Touch binary options are also known as one-touch binary options. It is the exact opposite of no-touch binary options trading. In one-touch binary options, the market price of the underlying asset much reaches the strike price at least once before the expiry.
The payout depends on the distance between the strike price, market price, and the expiry period. The further market price is away from the strike price, higher the payout. Longer the expiration period, lower the payout percentage.
There is an upper limit and a lower, in boundary binary options. Also, there are multiple price limits on ladder options.
The exact number of limits depends on the broker and the underlying asset that you are trading. Each limit has a different payout percentage. For each price limit, there is an ‘above’, or ‘below’ trade option.
Additionally, these are commonly referred to as ‘call’ and ‘put’ by most brokers. Like one-touch options, the payout for ladder options exceeds 100%. Each ladder is a different price point, which requires price movement from the current market price.
Greater the price movement, the higher the payout percentage.
Underlying Binary Options Assets
With Binary Options, you get the flexibility to trade on a variety of trading instrument. Among the many that are available, the most popular ones are stocks, forex, commodities, indices, and cryptocurrencies.
A stock represents a share in a company. When you purchase shares of a company, you gain ownership position. However, in the case of trading binary options, you are speculating on the price movement of the asset rather than owning it. You don’t own any portion of that company. Examples of popular stocks include Google Inc, Apple Inc, Barclays PLC, etc.
Binary options in forex mean one will trade options on currency pairs. Binary forex trading a popular choice for binary options traders because of their profitability and volatility.
A forex pair consists of 2 currencies: a base currency and a quoted currency. Popular forex pairs include EUR/USD, AUD/USD, USD/JPY, etc.
Commodities are real-world physical goods that mined, produced or manufactured by people. The prices of commodities changes daily due to geopolitical and environmental factors. Traders predict the price movements, whether it will go up or down. Popular commodities are gold, silver, crude oil, wheat, etc.
Indices are a portfolio of stocks that are all a part of a particular market sector. It allows for more diversification of risk as you are trading on multiple stocks instead of a single one. Other examples of indices include the S&P 500, FTSE-100, DAX-30, NASDAQ, etc.
Cryptocurrency is a decentralized digital currency that ensures the safety of transactions, using cryptography.
The crypto market is generally volatile. Great profits can be made if you trade in the right way. Popular cryptos include Bitcoin, Ripple, Ethereum, Stellar, Tether, etc.
How To Trade Binary Option
It’s a small reminder that trading binary options could be easier for one if you follow these basic guidelines. We have compiled all these things in one place so that one can review in two minutes before starting the day.
1. Choose A Regulated Broker
The first step is to choose a binary options broker. There are many fraudulent brokers out there that you must be aware of.
On the other hand, there are some factors that one need to consider before start with a broker.
Maximum Payout: 100%
Demo Account: Yes
Maximum Payout: 93%
Demo Account: Yes
Maximum Payout: 95%
Demo Account: Yes (Paid)
2. Choose The Market & Asset
Choose your preferred market and then an asset from that market. Make sure you trade on those assets that you have prior experience and knowledge.
For example, if you are a crypto trader, stick to cryptocurrencies.
3. A Proper Expiration Time
An expiration time is an important factor for binary traders. The outcome will depend on a proper expiration time.
Moreover, the expiration times can be as low as 30 seconds. But in a short expiry time, it is a bit harder to predict the price than longer expiration time.
4. Allocate The Amount
After selecting the expiration period, you have to choose how much money you are willing to invest in the trade. With binary options, you may lose your entire investment due to its all-or-nothing nature.
Hence start low, especially if you are a new trader. Invest low and work your way up using targeting small profits per trade.
5. Place A Trade
Check every detail and confirm the trade. After the trade expires, you will know whether you have made money or lost the trade.
If you win a trade, the payout percentage will directly add with your account balance.
Most traders are unaware of the basic guideline that we mentioned above. A few small things will help you in the long run by increasing the winning chance.
Additionally, along with these guidelines, to be a master in binary trading, you can follow these amazing 7 professional trading tricks. These tips will help you to bring a revolutionary change in daily trading life.
Is Binary Options Legal?
Binary options recognize as a legitimate investment type in many countries. But the rules and regulation of trading binary options in the USA are different than other countries.
According to our research and statistics, binary brokers are now focusing on trader’s benefits. Moreover, regulatory bodies maintain the regulation process properly.
So binary options brokers now proudly proclaiming that they are licensed and regulated by famous and non-famous regulatory bodies.
It is necessary to mention that “ all trading is gambling without any strategy”.
Luck is not involved much to win at binary options. If you want to win a trade or to have great success, a lot of effort and research is necessary.
Binary Trading Advantages
Binary option offers some unique advantages to earn quick profits. The most popular advantage is that it is a simple trading type with a large reward.
We have listed some of the major advantages down below:
~ High Payout Percentage
Most popular brokers offer very high payout percentages (upwards of 90%). A high payout percentage makes these brokers very attractive to all kinds of traders.
At the very least, you can earn 75% payouts. Compared to other trading methods, binary options have better returns.
~ Simple Nature Of Trading
Nothing is simpler than binary. You either win money or lose everything. Moreover, Binary trading’s simplicity attracts many beginner traders to try it.
Other forms of trading are far more complex and may intimidate new traders.
~ Fast Placed Trading
Binary trading is usually meant for short-term trading. As we mentioned before, with binary options, your expiration can be as low as 30 seconds.
It makes the trading experience fast and exciting. Although, a bit risky, but you can earn some quick cash using this form of trading.
~ Flexibility In Time
As discussed in the previous point, traders can trade binary with a low expiry time.
But that doesn’t mean you cannot trade long-term with options. Your trades can last as long as a year. With such variety in expiry times, binary options can cater to all kinds of traders.
~ Flexibility In Trading Instruments
With binary options, you are not limited to one or two asset types. There are multiple types of assets offered by binary trading such as forex, stocks, indices, and some more.
In binary trading, you don’t have to buy anything. A trader will only trade on the movement or change of the value of underlying assets.
~ Low Initial Deposit
Most binary options brokers offer low initial deposits so that new and small traders can get started. Some of the brokers demand as low as $5 or $10 as initial deposits.
Moreover, you can start trading via a demo account by using virtual trading currencies.
Disadvantages To Binary
Binary options are generally considered as a safe investment option for all types of traders. However, any form of investment carries a high risk. Along with the benefits, trading binary options also possess some disadvantages.
We have listed the major disadvantages down below:
1. Consider Trading Binary Options As Gambling
In binary options, you are speculating on the price movement of the underlying asset. In essence, you are predicting future value on an uncertain outcome.
However, it is a highly debatable topic as certain traders argue that using a trading strategy instead of blind predicting in gambling.
At least on the surface, binary options are structured just like a $100 bet on a football game: You buy the team you like, or you sell the team you don’t. A binary is just a simple yes/no trade. The yes trade means you agree with the binary statement that the market will reach a certain level before expiration.
For example, no-trade means you disagree. The pricing of the binary is between zero and 100 throughout the lifetime of the option.
Unlike football where the underdog will receive odds, the binary has a multitude of strike prices that have a variety of fixed odds.
2. Losses Are Substantial
If you lose your price prediction, you get nothing in return as well as lose your initial investment. At the same time, if you have placed a big trade worth thousands of dollars, you can lose it all in an instant.
So, if you decide to trade options, make sure you start with a small amount.
3. Not Permitted In Certain Locations
Binary options are a popular form of trading. However, it banned in certain locations such as Europe. Also, in some countries, you can’t perform trade using offshore trading brokers.
The European Securities and Markets Authority has placed a ban on selling binary options to retail traders.
4. Riskier Than Other Forms Of Trading
Like CFD or forex trading, you can’t control your losses, in case your position moves steeply against the market. You cannot place stipulations, such as stop losses or take profits to ensure your profit, and cut your losses.
In binary trading, you will lose everything for a wrong prediction. In 2017 ASIC review, it was found that nearly 80% of traders lost money with binary trading.
The probability of accurately guessing the outcome of a binary trade is lower than you think.
The mid-point of the buy price and the selling price can be used to forecast either the trade will be successful or not. On the other hand, the success rate is often between 10-20%. It boils down how well you perform your trading analysis.
Finally, there is the risk of the counterparty. If your broker fails to deliver your payout, it will be troublesome for you to get your money back.
Finally, we are at the end of this article. There are so many other things that you should need to remember while trading this financial product. However, this article is intended to be a binary options guide.
We cover all the basics information with examples. Hopefully, this article will guide you if you want to make money through binary options.
Moreover, we hope after reading this article, you now have a basic understanding of how binary options works and its benefits. It is advisable to start with a small investment.
Invest in those markets that you are comfortable with. Take trading losses as a lesson instead of a setback.