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What Are Binary Options? A Complete Guide

Your capital may be at risk. This material is not investment advice.

The number of contracts on options and futures traded globally in 2017 was worth $25,199 billion. Of these contracts, the total value of options traded was up 11%.

With the cooling off of return rates globally, many people have turned to binary options as a revenue channel.

While it is indeed promising, it is essential that a potential investor know what entails trading a binary option to comprehend its risk-reward profile.

Here is a primer on what you need to know before jumping into trading a binary option.

What is a Binary Option?

This is an exotic financial investment option where you either make some fixed amount, or you lose.

To better understand a binary option think of it as a ‘yes’ or ‘no’ investment instrument. Here, your job is to predict whether a particular asset class will be below or above a specific price at a particular time.

Due to the simplicity of this foundational concept these options are attractive to traders with low-skills as they are easy to understand.

The cornerstone strategy of this investment is, therefore, prediction, and that is a critical issue to put in mind.

When you predict that an asset 9 will be above a certain price, you are voting ‘yes’ and buying it. Conversely, if you predict that a particular asset class will fall below a specified price, you are saying ‘no’ and selling it.

How Do You Make Predictions?

While prediction is at the core of binary options trading, it is not an easy thing to do. No one can tell the future and yet you have to attempt it if you want to trade binary options successfully.

The goal here is to make a prediction backed by as much information as possible. The following are some tips to guide you.

1. Use a Demo Account

When you’re starting with binary options trading, it is advisable first to practice using demo accounts.

A demo account you will allow you to identify and grow your prediction strategy without suffering actual financial loss.

Practice helps you gain crucial skills needed in data collection and analysis for better prediction.

Free Demo Account
The financial products offered by the company carry a high level of risk and can result in the loss of all your funds. You should never invest money that you cannot afford to lose.

2. Understanding Your Market

When you are delving into the binary option segment, it is prudent to pick a market and stick to it first. If it’s the S&P 500 you are seeing through, focus on it only. If you are interested in currency trading, then stick to looking at forex.

That laser-like focus on one market will give you the domain knowledge you need to be familiar with the visible and invisible dynamics.

When that kind of knowledge is at your fingertips, you can be able to spot patterns for better predictions.

3. Use Technical Tools for Analysis

Technical analysis tools help you critically study the history of the asset class to see better what it is doing. A price chart is the most common tool you can begin to use.

A chart pattern will show you whether an asset’s price is going down or up for a High/Low or Up/Down trade. It can also help you determine if the asset is moving sideways for a boundary trade.

4. Track Your Trades

Making a note of your historical binary options information can help shape future strategies. When you can see what went wrong or right in the past, you can improve the quality of your predictions as you go along.

You can do this using a notebook or a trading platform if you are binaryly inclined.

Assets You Can Trade in Binary Options

The type of asset you can trade depends on the broker you decide to work with. These assets include:

  • Individual stocks
  • Forex
  • Economic events, e.g., the federal rate adjustment
  • Commodities e.g. corn, steel, soybean, crude oil, etc.

Since your broker will play such a critical role, it is essential that you identify and work with regulated ones to avoid getting duped.

How a Binary Options Trade Works

A binary options contract will cost you not more than $100. When you buy a contract, you aren’t purchasing the underlying investment or even an option to buy it. You are just betting what you think its price movement will be like.

Let’s imagine that you want to trade on the S&P 500. In this imaginary trade, you chose a contract whose strike price (the price limit you place) is slightly higher than the market right now.

Therefore, you want to predict if the S&P 500 will be above the imaginary strike price of 1,075 at 1 p.m (its expiry date).

If you think it will, you buy the option at the offer price. If you think it won’t, then you place a bid price and sell the option.

Let us set the bid price for our imaginary contract at $30 and the offer price at $40.

If You Buy the Option

If you predicted that it would be above $1,075 at 1 pm., bought the contract and you were right the option will settle for $100. That means you earn a $60 profit.

If after your bet the S&P 500 ends up being below the $1,075 strike price at 1 pm you will have made a wrong prediction. As a result, you will lose the $40 as the option settles at $0.

If You Sell the Option

If, on the other hand, you predicted that it would be below $1,075 at 1 p.m., sold the contract and you were right you earn the bid price as your profit. The option will settle at $30.

If after selling the contract the S&P 500 doesn’t end up below $1,075 at 1 p.m. you will lose $60. The loss will be $100 less the $30 bid price.

The Bottom Line

In the face of reduced investment returns globally, trading in binary options has provided a reprieve to some investors.

It is critical that any investor looking to wade in the water first grasp the nuances of trading these options for a more realistic outlook.

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Author info:
Author: Kungawo
Kungawo is from: South Africa, Cape Town
Please be advised that certain products and/or multiplier levels may not be available for traders from EEA countries due to legal restrictions