Binary options trading is gaining popularity and fast becoming one of the easy ways smart people earn money online. However, of all the financial instruments that are traded such as spot forex, stocks, commodities and indices, binary options are the most controversial and often misunderstood. So let's talk about it.
If you ever thought about making money online by trading in binary options and you wish to get some knowledge to get you started, then this post is meant for you.
Now let’s dive in.
What Is Binary Options Trading?
First what is an option?
An option is a derivative instrument. It is a financial contract in which one party agrees to buy from or sell to the other party, an underlying asset at an agreed price and at a time in future.
Let’s explain this further: Mr. A has 1000 units of an unquoted company shares which is currently selling at 25 per share. Mr. B wishes to buy these shares but wants to do more research on the company before taking a decision. The two parties enter into an option contract which requires Mr. B to pay a fraction of the price now, say 5 per share and in three months’ time has the right to purchase the stock at the current trading price of 25.
Sometime within the contract period, a major news hit the market that catalyzes investors interest in the stock and the price jumps to say 50 at the end of the three-month period. Mr. B buys the stock at 25 and makes a 100% profit on the transaction for himself.
Option contracts are used for hedging and speculating purposes. Thus, in our example above, the price of the stock could also slump and Mr. B would have made a loss on the transaction.
Options contract are settled through the exchanges; hence they are described as exchange traded options to differentiate them from the new class of option contracts that are largely executed over the counter.
Binary option is one of the newest but fast becoming the most popular derivative and over the counter product in the financial market. In binary option trading, the trader is required to predict the outcome from two possible results within a given period of time,.i.e whether the price of an underlying asset will go up or down from the strike price for fixed payout. If your prediction is right, you receive the agreed payout, if not you lose only the amount of money you staked.
This is why it is called binary – there can only be two outcomes i.e win or lose. The pay out can be as small as 50% or as high as 90% depending on the broker.
Large investment banks have traded binary options over the counter until as recent as 2008 when it became somehow democratized to allow retail investors who had been trading forex to come in.
The underlying assets traded on binary options include forex (currency pairs), stocks, commodities and indexes.
While exchange traded binary options are settled against the United States Exchanges, the OTC binary options are largely online and settled against the Broker. This is the first source of risk.
You can trade binary options in four easy steps
Step 1: Sign up with a broker – This is a very important step because the broker you use will define the kind of experience you have. Many people have had nasty experiences with some of these online brokers.
Choose a registered and regulated broker, tested and trusted like Binary.com. Binary.com is an award-winning trading platform; suitable for both experienced and new traders. Open a free account with binary.com and experiment with their demo account to understand the environment and gain some confidence before funding your account with an amount as small as USD10
Step 2: Define your position – This is simply setting the parameters for your trade. It involves selecting the underlying asset you want to trade on (currency pairs, commodities, stocks or indexes), getting the strike price and setting the duration. It is at this stage also that you select the trade type.
There are different kinds of trade types to chose from, namely up/down, in/out and touch/no touch. The most common trade type is up/down. In up/down trade, all you are required to do is predict whether the price of the asset will go up or down within the set duration.
Step 3: Get your price – the price of the contract is automatically calculated once you have finished defining the parameters in step 2. Binary.com uses patented technology to get prices which are benchmarked against interbank options market.
Step 4: Execute your trade. When you are done setting all parameters, taking a stake and calculating the price, execute your trade by clicking on the purchase button if your are buying the contract or the sell button if you are selling.
Advantage and Disadvantages
When compared to other kinds of financial trading like forex, binary options trading have some advantages. Some of these are:
- It is simple – Binary options trading is very simple. Once you have decided on a broker and make a deposit, all you need do in executing a trade is predict the direction of the market. No complex analysis.
- All instruments – You can trade all the instruments on one account, namely currency pairs (forex), commodities (gold, silver, etc), stocks and indices
- Little Investment – Unlike forex trading, binary trading requires little amount of money to start your trading. Small brokers such as binary.com accept as little as USD 5 as initial deposit to commence trading. So, you can manage your risk by starting small and increase the stakes when you become more comfortable.
- Minimal risk – The risk in binary options trading is minimal because you can control your trade by investing small. Even when you have large amount in your account, you still control what you stake per trade, unlike forex where you trade the whole account per transaction.
- Returns are high – In binary options, you can earn as high as 90% of the amount of you staked if you predict correctly and within a very short time span, say 15 minutes. If you lose, you only lose the amount staked in the trade.
On the downside, the following are the pitfalls to watch out for if you decide to trade binary options:
- Fraudulent brokers – There are quite a number of fraudulent brokers who are out to swindle unsuspecting traders. Watch out. Always use credible brokers like binary.com
- Possibility to lose your entire investment in one go – This is a huge disadvantage. In binary options trading, there are only two options – you win or you lose your entire investment per transaction. Smart traders mitigate this risk by staking in smaller amounts.
- It is largely an unregulated market. This is the reason there exist a lot of unscrupulous brokers who swindle traders by either not letting them withdraw money from their account or not meeting up with pay out agreements.
- Binary options trading is highly speculative. Therefore, no matter the level of analysis the luck element cannot necessarily be ruled out.
Selecting A Broker
A very important decision you will make in your attempt to trade binary options is the choice of a broker.
The need to exercise due diligence in choosing a binary options broker cannot be overemphasized. To guide you in your choice:
- Consider the safety of your deposit and the assurance that you are able to withdraw your winning cash and entire investment when you need it.
- Consider the integrity and reputation of the broker – binary.com is an award winning trading platform
- The regulatory environment of the broker – binary options trading in itself may not be regulated but it is important that you trade with registered brokers who are under the regulation in their respective jurisdictions
- Use a tested and trusted broker
About Pay Out
Pay out is what you earn for winning your trade. It comprises of amount staked plus the percentage profit. If you invested 100 in a call option at 80% pay out and you accurately predicted the trade; your earning will be 180.
Now each broker has its own pay out rate but most range from 50 percent to 80 percent. Some give payout as high as 90 percent. Some of the factors that brokers considered in deciding their payout rate include the type of underlying asset traded, the expiration time and broker’s commission.
How to Make Money In Binary Options Trading
It is possible and easy to make money by trading binary options if one is able to develop some winning strategies and stick to them.
I highlight some strategies that some successful traders I interviewed for this post have adopted to consistently win their trades.
Here they are:
- Use of Signaling Services – There are companies that provide trade signals to traders. These companies have expert staff whose responsibilities are to analyze economic and market data, making it possible for them to predict the market correctly. These companies push these data daily to their subscribers who use them as guide to trade. Such services will take the rigour of researching and pouring over enormous data from you so that you concentrate on trading and making profits.
Successful traders that I know subscribe to at least one signal service. Newbies who may not be able to pay for such services may use the free signal websites like barchart.com. Though free services come with its limitation obviously but they can be helpful to get you started.
- Spend some time to get knowledge – knowledge is key in financial market much more so in any form of derivative trading. Study relevant materials, get a level of understanding of how things work. Reputable options brokers like binary.com provide tutorials that can be very helpful.
- Use technical indicators – Technical trading is strictly the use of price actions to predict the future direction of assets. The most common technical indicators are Moving Averages (MA), Moving Average Convergence Divergence (MACD), Relative Strength Index (RSI), and Bollinger Bands.
Find out the indicator that works for you and use it.
- Start with a Demo account to understand the trading platform and gain some confidence trading
- Trade securities you are more comfortable with – Many brokers offer traders the choice of trading in four underlying asset classes namely, currency pairs, commodities, stocks, and indices. Select the asset class in you have some understanding. If you have traded spot forex, it is likely you will be understanding how currency pairs work more than others. So, with stocks and the other assets.
- Trade small size – It is a good risk management programme to trade in small sizes. Do not get greedy or over ambitious. It helps you limit your losses. The win may be small but with patience and consistency, you will accumulate huge payout.
Most people fail because they want to accumulate millions overnight!
Binary option trading is one good way of making money online. Like it is with most investments, trades or businesses, it comes with its own benefits and of course risks.
To succeed, use a reliable broker such as binary.com. It also pays to learn and get sufficient knowledge. Finally, don't be in a hurry to trade. Test the waters with a demo account, study technical indicators and trade in small sizes.