Difference Between Binary Options and Forex, Stocks Trading

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Trading Stocks

Trading stock binary options takes some understanding of how stocks behave in order to profit from it.

Stocks constitute one of the asset derivatives that can be traded on the binary options market. Usually, a trader will have access to trade hundreds of stocks, as brokers will list several stocks from the different stock exchanges across the world. A good spread will include stocks from the three American exchanges, the London stock exchange, and the stock exchanges from Germany, Spain, Switzerland, the Eurostoxx exchange (which contains stocks of companies in the Netherlands, Belgium, and other central European nations) as well as stocks from some selected middle East exchanges. This gives traders and unbelievable spectrum of stocks to change.

What Factors Should you Take into Account when Trading Stocks?

In order to trade stock binary options, traders must be conversant with the factors that cause movement in stock prices. Some of these factors are as follows:

1) Market sentiment: if there is a gloomy market sentiment and worry about the global economy, most investors will prefer to hold cash and will sell their stock holdings, leading to a fall in stock prices.

2) Earnings reports: A good or bad earnings report will cause a stock price to rise or fall respectively. What constitutes a good or bad earnings report? A company reporting a loss may look bad, but if the loss is less than a previous loss, this may be viewed in a positive light by investors, leading to increased demand and a rise in the price of this asset. Conversely, profits declared by a quoted company may not necessarily be viewed in good light, if the profits are less, or are viewed as an underperformance when compared with its peers for the period. The trader must have access to historical data to be able to use factors like earnings reports for stock binary options trading. Another limitation to the use of earnings in trading stock binary options is that they are seasonal and can only be used during the quarterly earnings season.

3) Mergers and Acquisitions: A merger or an acquisition is meant to improve the standing and competitiveness of the companies in question, and usually have a positive impact for the companies involved.

4) Government policies: these could have a positive or negative effect on stock prices. For instance, increasing import duties on raw materials for a particular industry could erode the profit margins of affected companies and negatively impact their ability to remain competitive against foreign goods. On the other hand, import duty waivers could enhance profitability of the same companies in question.

How to Trade Stock Binary Options

The first step is to identify in what direction the stock is likely to head after a news release affecting the share price of the company in question. From there, the trader is free to choose any binary options trade type to fit his trade profile. For instance, an earnings report can lead to a sustained response that lasts for many days. In such a situation, the trader can decide to trade the Touch/No Touch option, using an appropriate price barrier while taking into consideration any recent supports or resistance levels.

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If there is a particularly strong news release that is likely to cause the share price of a company to spike in any direction, the trader can decide to trade any of the high-yield option varieties. For instance, the sudden announcement by the CEO of JP Morgan about the trading losses recently incurred on its positions is the kind of news release that can lead to a move so hard that it could breach the price barriers of the high-yield option types. It is ultimately up to the trader to determine what kind of trade will suit the news release he wants to trade.

The difference between binary options and forex

Although traders experienced in trading financial instruments such as foreign exchange can put some of their existing skills to good use in binary options trading, it is important to remember that there are substantial differences between the two.

Trading binary options therefore requires a unique approach.

In this lesson, we will outline some of the key differences between trading forex and trading binary options as well as some of the similarities. This will help you decide which type of instrument you are better suited to trading or, if you choose to trade both, be aware of what needs to be done differently.

Betting versus trading

Although binary options are quite rightly referred to as financial instruments, there are some ways in which they are akin to gambling.

For example, the fact that you know in advance exactly how much you will earn if a trade moves your way makes binary options trading similar to fixed-odds betting on the results of sports matches or other events. Many traders regard binary options as a fast way to win (or lose) money.

For this reason, some countries continue to regulate binary options as a gambling instrument rather than a financial instrument (see Lesson 2 for more information). This is however changing.

In contrast, foreign exchange trading has a real practical purpose for the countless corporates and financial institutions across the world that use the market to facilitate international trade or to hedge currency risk on overseas income and expenditure. Individuals who trade foreign exchange also tend to take more of an investment approach, sometimes trading FX to diversify their trading portfolio or hedge risk on other financial instruments such as company shares or commodities.

Binary options are less complicated

Binary options trading is also generally less complicated than trading foreign exchange.

For example, the size of your payout with a binary option does not change depending on the size of a price move – all that matters is whether a certain point is reached or not. There is therefore no need to actively manage positions once you have entered a trade.

In foreign exchange, however, you earn (or lose) progressively more depending on how far in a certain direction the price of the underlying asset moves. For this reason, it is necessary to manage positions closely to avoid racking up excessive losses, or to use risk management tools like stop losses to automatically exit you from a trade that moves against you.

It is worth noting however that with both binaries and forex, trading can be as sophisticated or as simple as you choose, depending on the level of analysis you undertake and the trading strategies you use.

You cannot lose more than you invest in a binary option

With binary options, you know in advance how much money you will win or lose depending on the outcome. You also cannot lose more than your initial investment. Knowing from the outset what your maximum loss will be makes it easier to manage risk.

In contrast, foreign exchange profits and losses shrink and grow in line with the size of price moves. Losses can easily exceed your initial investment, subjecting you to a margin call. Because of the leverage employed in foreign exchange, such losses can also mount up quickly.

Only some forex trading skills are applicable with binaries

Because of the above, even traders with experience in trading foreign exchange will need to develop new skills and a fresh approach when trading binary options.

They should however find themselves at an advantage compared with complete novices in financial markets.

Skills that foreign exchange traders can put to good use in their binary options trading include technical and fundamental analysis, basic money management, and knowing how to develop a trading plan. Some more intangible benefits that also come with experience are being able to keep a cool head and knowing what time of day you tend to make your best trading decisions.

Summary

So far you have learned that:

  • you can trade almost any popular financial instrument through binary options
  • you can profit from binary options if you correctly predict, whether prices will finish above or below a certain point at the expiry of the options contract
  • with a ‘call’ option you speculate on rising prices, and with a put option you expect prices to fall.
  • the ’market price’ is the actual price of the underlying instrument, and the ‘strike price’ represents the level that is judged against the market price upon the expiry of the contract, to determine how your bet performed
  • ‘in the money’ refers to an expired option that met the predefined criteria and turned a profit; and ‘out of money’ means the option did not fulfil the criteria and you need to take a loss
  • there are many different types of binary options such as: high/low options, one touch options, double touch options, no touch options and boundary or range options

Understanding the Difference between Binary Options and Forex Trading

Currency trading has existed since the ancient times. Today, the global forex market is one of the largest and most liquid markets in the world. Binary options, on the other hand, are the new kid on the block. Many say that binary options are new versions of forex trading, maybe even simpler, which makes it a preferred instrument for many new traders. At the same time, binary options are also associated with high risk and bad practices in the market.

Understanding the differences and similarities between these two modes of trading is crucial to making informed trading decisions. So, let’s take a look at what binary options are first.

What are Binary Options?

Binary options are a type of exotic option, derivatives that can have several triggers related to the calculation of pay-offs. Nevertheless, these are quite complex, compared to the regular vanilla options. The pay-off is either a fixed amount or nothing at all, hence binary. Two types of binary options exist – cash-or-nothing binary option and asset-or-nothing binary option.

In the former, a certain amount of cash is paid on expiry, which depends on the relative position of the current price of an underlying asset, in relation to the strike price of the options derivative. In the latter option, the value of the underlying security is paid off.

The price of binary options can be determined through the Black–Scholes model of valuation.

Until quite recently, binary options were primarily considered a form of gambling and have been associated with many fraudulent activities. Even today, countries within the European Union and Canada do not allow trading in these financial derivatives. In January 2020, the UK FCA gained control over the binary options market from the gambling commission. By December 2020, the FCA had banned the sale, marketing and distribution of binary options to retail clients. In the United States, binary options in exchange-traded formats are approved by the US SEC.

Before we move on to learning the differences between binary options and forex trading, let us look at the ways in which they are similar:

  1. Dependent on Asset Price Prediction: Both instruments work on the basis of predicting movement and direction of asset prices. Based on these predictions, traders assume buy and sell positions.
  2. Huge Profit Potential: If done right, both can offer good profit opportunities. Experts say that binary options work just like Roulette, if your prediction is right, you get back your money plus additional returns.
  3. Risk Involvement: When there is huge scope for profit, risks tend to be higher too. Traders can witness quick and big losses, just as they can earn quick and big gains.
  4. Trading: Both are tradable online and both can be started with small amounts of capital.

Differences between Forex Trading and Binary Options

1. Variability – Higher Variability Means More Risk

In the binary options market, investors only predict whether asset prices will go up or down in a certain period of time. There is no variability in terms of risk and profit potential.

On the other hand, in the forex markets, traders don’t just predict the direction of currency prices, but also the amount of rise and fall in value. This offers high variability in the risk-reward ratio. The ultimate level of risk and profit remain unknown. On the whole:

  • If currency prices rise, it is a signal to buy. Profit potential will increase with a rise in price.
  • If currency prices decline, it is a signal to sell. Profit potential will decrease with a fall in price.

2. Difference in Expiry Times

In binary options, timeframes and expiry can vary from 60 seconds to as long as 3 months. Each trader must select the timeline before entering a position. In short, there is a start and end time. The trade closes automatically at the end of the timeline.

Forex trading has no such timeline. Traders have the flexibility to open and close trades whenever they wish to. Positions can continue for months or even for years. This is advantageous, but could prove tricky under some conditions.

3. Concept of Margin or Leverage

Forex trading has an attractive yet risky tool, called margin. Traders can enter into positions much larger than the available capital at hand. They can make significant profits using this tool, and also suffer magnified losses when the markets go against them.

Margin or leverage is not available for binary options trading.

4. Trade Management Flexibility

Aside from the high/low options, most binary options are available at certain times in a day or week. The strike price is also set by the broker. In forex trading, one can enter limit orders at any price, or enter into market orders at any time of the day.

Some binary options also have rules regarding the stipulated time, before which you cannot close a trade. In the forex markets, you can close a trade anytime you want to, meaning you can exit positions to cut losses.

5. Transaction Costs

Binary options do not include transaction costs, unlike forex trading, where commissions, spreads and slippage are common terms. However, pay-out in binaries, may only be a percentage of your total.

6. Types of Instruments to Trade

Firstly, binary options are not restricted to currency pairs. They can include stocks, commodities and indices. There are mainly 5 kinds of binary options to trade:

  1. High/low
  2. Boundary options
  3. 60 seconds options
  4. Touch/no touch options
  5. Option builder

Forex trading consists of order types, like buy/sell, limit stop, trailing stop, hedge orders and more.

7. Volatility Risks

Binary options do not include unexpected volatility. In forex, sharp swings in price data can bring considerable differences in the bottom line. This makes the task of setting up appropriate risk management systems very important.

It is important to engage in proper research before trading binary options. Major countries regard them as “high-risk” and “unpredictable” financial instruments. Many binary options outlets have been termed as fraudulent by governing bodies across the world.

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