By: Christopher Lewis
Recently there has been a big push towards binary options in the trading world. Most traders still don’t use them, nor do they understand them. While the complete process is somewhat complicated, I will try to simplify it for you here, and give you a general overview and comparison so that you can decide if they are for you or not.
In order to understand the comparison, you should know a little about the binary option. The binary option is simple: It is either a “yes” or “no” answer at the end of a certain time period. For example, you may by a binary option that says the USD/JPY will be over 83.15 by 4pm EST today. (Many binaries are less than a week in length.) You pay $40, and if you win, you will get a payback of $100. Time goes by, and at 3:45, the USD/JPY has hit the 83.50 mark – well in excess of where you need it to be. You collect $100. That’s great!
Let’s take a look at the opposite scenario now. You buy the same binary option and the trading day goes by, as the USD/JPY plummets. This sends the pair down to 81.11 at the end of the binary’s time period. This is where people tout the idea of binary options. The loss is still just the $40 you paid for it. This is how an option works: You have a specific risk parameter that is the maximum you can lose. If you were in the spot Forex market, you could be down much, much more at the closing of the day. At least that’s what the binary sellers would have you believe.
But let’s take a closer look. This assumes several things. A trader certainly wouldn’t let a position tank on them like this. You have a defined risk – it’s called your stop loss. In the scenario where the pair fell, your stop loss would have got you out of the market. This also assumes that you were risking more than $40. It is very possible you are trading with a micro account, and might only be risking $20. Try explaining to the binary broker that you would only like to “buy half that position”. Good luck.
On the other hand, let’s think about if you were correct, and the USD/JPY shot up like the first scenario mentioned. At 4pm EST, if you are in the option – you are done. You take your $60 and go home. But if you are trading the spot Forex market, there is no real reason why you need to get out of the trade. For all you know, it could be the start of a whole new trend. After all, there are people out there that hold positions for years. (Thus capitalizing on the overall trend.) This is something that a binary simply isn’t built for. In fact, it is safer to hang onto a trade than getting in and out of it continually like the binaries would have you do. After all, markets pullback. Even that USD/JPY long you are holding onto. By managing your stop losses, you can control risk, and let the gains build over time as well.