Binary options have grown by leaps and bounds since the market was deregulated in 2008 for retail participation.
There is now a huge market for binary tipsters; those who scour the market and predict positive changes for their followers.
Known as ‘binary options signals’, these signs are supposed to let traders know when an option is on the move.
But is this really the case?
In this post, we break down the binary options market for you in simple language so you can understand what is really happening here.
What Are Binary Options?
If you’re wondering ‘what is binary options trading?’ then this is it described in a way that you will understand:
A trader – that would be you – is presented with two possible options or outcomes for a financial asset.
That sounds complicated, but what it really means is that you essentially have the choice to bet on whether a financial option will increase or decrease in price. Only one can be correct within the allocated time for each trade.
If the asset behaves according to the choice made by the trader, a fixed profit is made. If not, the investment is lost.
For a beginner, this would be like putting your money on red or black on the roulette table…but with even less chance of winning.
Various scenarios can be traded as binary options. For instance:
- A trader can bet on whether the price of the asset to be traded will end up higher or lower than the entry price. This is the Up/Down or High/Low option.
- A price can be set at random by the broker, and the trader has to bet on whether price movements of an asset will attain this set price. This is the One Touch option.
- Prices can move in a tight range or break outside a range of prices. This is the In/Out option, where the trader bets on whether the price of an asset will stay within a price floor and ceiling, or move above the ceiling/move below the floor.
Other forms of binary options exist, depending on which broker is used.
Operators in the binary options market tout them as being easier to trade and by extension, easier to make from when compared with other forms of investment.
These operators in question have been proven to have some extremely questionable business practices, but more on that later in this post.
How do Binary Options Work
A trader is presented with several types of binary options, each with the two possible outcomes that we’ve mentioned above.
The trader chooses an asset, selects one out of the two provided outcomes, sets an amount to be invested in the trade, chooses an expiry time from the various options listed, and executes the trade.
Again, this sounds a lot more complicated than it is. Think of it like betting:
It’s like picking the match you want to bet on, and then you’re choosing to bet on whether a team will score 2 goals or less, or 3 goals or more.
Each successful trade comes with a payout which is listed against the option. It’s not like you’re making an investment that could yield a broad figure over time…you always know the exact amount that you will win or lose.
If the outcome chosen by the trade turns out to be the right one, the trade is deemed successful and the trader receives his initial investment and the payout.
The payout is a percentage of the invested amount and is usually between 65% and 80% of that figure.
If the outcome chosen is wrong by the time the trade expires, then the trader will lose all the money that they invested into the trade.
In other words,
- If a trader chose a HIGH in a High/Low option, invested $100 with a 80% payout, and the price ended up higher than the asset price on trade entry, then the trader gets $180 ($100 + [80% of $100]).
- If the trader invested $100 into this trade and the price instead ended lower than market price, then the trader will lose the entire $100 invested.
Binary options trading is an “all or none” type of investment.
You either win all that is on offer, or you lose all you have invested.
The Risks Involved in Binary Options
Many people do not understand the risks with binary options trading.
It’s easy to get lured in by the fabulously designed sales pages of the profits that can be raked in by trading with a magic robot or system. More on those sales pages later on in this post.
To help you understand the risks, we are going to break it all down and do the numbers behind the façade.
A well-known forex trader known as Bill Lipschutz credited his immense success in forex to one thing:
Picking out trades where the reward-risk ratio was very high.
In other words, this meant picking out trades where it was possible to make at least 3 times what could possibly be lost.
This strategy does two things:
- Enables you target big wins with minimal risk.
- Puts you in a position where you can lose more trades than you win and still end up in profit position at the end of the day.
Here is how it works.
A forex trade is usually setup with a profit target (Take Profit or TP) and a stop loss (SL).
The essence of Lipschutz’s trade strategy was to pick out trades where he stood a chance of making at least 3 times his profit, for every 1 time he hit his stop loss. So it would take three losses in trades of similar magnitude to wipe out a win on one single trade.
With binary options, this is not the case.
There is actually significantly more risk involved when it comes to risk-reward ratios.
As you may have realised, no binary options trade pays out 100% for a winning trade. The maximum profit payout is 80%, but the possible loss is 100%.
- If you invest $100 and you choose the correct option, you get $65-$80 as payout.
- If you invest $100 and you are wrong, you get $0.
With this structure, you need to win an absolute minimum 60% of the time just to break even. This means you are always under pressure to win and to win often.
The real difficulty is that the majority of people are just guessing – even if they don’t feel like they are – meaning a 50% long-term success rate is typical, but nowhere near profitable.
Chasing losses by using larger trade sizes is a common problem that can put traders in increased financial trouble.
Broker Conflict of Interest
Three entities are in a binary options trade at any given time:
- The buying party
- The selling party
- The broker/market maker
The brokers may look like very innocent players in the game – acting like the croupiers in the casino – but in reality, they are not.
The brokers are actually the major gainers in binary options and this is how they do it…
Let us assume we have two traders, John and Jerry, on two sides of a High/Low option for Gold.
They both invest $100 into the gold option and are seeking an 80% payout. John chooses HIGH, while Jerry chooses LOW.
At the beginning of the trade, the broker holds onto the $200 invested by both traders.
The price of Gold rises, John wins and is paid $180 ($100 investment + $80 payout). Jerry loses the trade as well as his initial investment.
The broker only has to pay out $180 of the $200 invested by both traders, and pockets $20!
They would still have pocketed $20 even if Jerry would have won the trade.
Now imagine how much money the brokerage business makes if there are 100,000 traders invested in a trade, with half of the traders on the losing side.
If the traders hypothetically invested $100 each, the broker would walk away with $20 X 50,000 = $1m.
If the brokers were to stick to this model of profiting from the business, then binary options would indeed be a transparent business…
But sadly, many brokers in the binary options market have more sinister intentions and actively tweak the market to ensure they make more money than is due to them. How do they do this?
How Brokers Manipulate the Market
In trades, were the outcomes to seem more certain than ever (e.g. in a news trade where the asset price direction can be correctly foretold by close to 90% of the traders), the brokers either freeze their platforms or they make the affected assets unavailable for trading.
This denies traders the opportunity to make guaranteed money, but brokers explain this away as being part of their risk management strategy.
The fact is that if too many traders profit from trades, the brokers will be unable to pay. Binary options trading is a zero sum game – only money collected from losing traders is used to pay the winners.
A more sinister trick used by brokers is to manipulate the prices of assets, especially those on short term trades such as the 30 seconds or 60 seconds trades.
They know that in these trades, most outcomes will depend on a single pip or half a pip (that’s a small change in price to you and me).
Since the brokers are responsible for receiving price feeds and setting prices for binary options, it is actually possible for them to skew prices to screw traders out of profitable trades.
Below is a clear representation of how a broker cheated a trader out of what should have been a profitable binary option:
The disputed trade in question is a High/Low trade for the AUDUSD currency.
The trader chose the HIGH option and invested $50 at a price of 0.75824, for a full payout of $90.50 (including his investment stake).
According to the broker’s price feed, the trade ended at 0.75824, which was an ‘at the money‘ outcome, which should lead to a return of the trader’s invested amount with no profit made for both parties. The trade ended at 1:45:00pm. But was this really how the trade ended?
A look at the price feed of a forex chart indicates that the 15-minute candle in question closed at 0.75856, which was higher than the 0.75824 price listed by the binary options broker.
The trader should have earned $90.50 from this trade, but the broker decided otherwise and listed a price that wasn’t a true indication of the market.
Sadly, these cases of price manipulation on the part of the binary options brokers are not rare.
Many cases are undetected as only the most-trained eyes with the right tools can spot them.
Is Binary Options a Scam?
There are many scam operations going on at the moment in the binary options industry.
Sadly, this has been some sort of collaborative effort on the part of brokers and unscrupulous companies, coming together to rip of traders of their hard earned money.
Let’s take a look at a few of the ways that traders have been, or are being, scammed in the binary trade:
Before 2013, a time when some sort of effort was made to keep the industry clean, there were boat loads of scam operators in the market.
Many of them posed as brokers.
These operators found some loopholes in the system and cashed in big time to game the system.
The first loophole they discovered was the categorisation of binary options as a gambling enterprise.
No longer did you need to be financially regulated; you could just pose as a gambling outfit – without actually disclosing that to your customers or site users.
This made the financial regulators who should have been the watchdogs simply look the other way while bucket shop operators entered the fray in large numbers.
For instance, there was a time when you could open a binary options brokerage with just $20,000, access to turnkey trading software and perhaps a company name (registered or unregistered).
There were no reporting requirements, no minimum capital requirements, no segregated account systems and no form of regulatory oversight.
In one sad case, a reputable binary option brokerage was discovered to be a husband-and-wife kitchen operation.
This was only found out after they had eloped with traders’ funds that totalled hundreds of millions of dollars.
Many traders were taken to the cleaners.
It was only when the Cyprus Securities and Exchange Commission (CySEC), the Maltese Financial Services Authority and a few other regulators in countries which served as havens for these operators decided to step in that the carnage from unregulated entities stopped. But the damage had been done.
The Bonus Trap
One common denominator among online binary options brokers is their penchant to offer traders bonuses which range from 50% to 100% of account opening size.
This is usually offered to new traders without an explanation of what accepting a bonus really entails.
The bonus is usually provided as matching capital to enable the user trade binary options with larger trade sizes.
But here is the caveat: you need to generate a trading volume which is at least 30 times the bonus amount in order to withdraw the bonus. Of course, you cannot withdraw any profits made until this volume requirement is met.
This is something we regularly see with casino sign-up offers, but at least the majority of them are profitable long-term.
You may not realise how tough this wagering requirement is until you actually begin to trade.
A bonus of $2,000 means that the trader must generate trade volume of $60,000 to be able to make withdrawals on the account. This means trading $100 positions 600 times.
The brokers know that new traders will not be able to trade as many times as this without getting their accounts blown.
So the bonuses are simply used as a ploy to ensure that the traders lose all their money.
Is it any wonder that bonuses as a tool to entice new traders has been banned by regulators in Japan and Australia?
Brokers as Counterparties
Recall that in the earlier parts of this article, it was pointed out that there are usually three parties to the trade.
In some cases, there are just two: you and the broker.
When brokers act as market makers, they will routinely assume the role of the counterparty (the person you’re betting against) to a trade.
Now imagine yourself in a situation where your opponent is also the umpire; how would that work out for you?
This is exactly what traders facing brokers as counterparties in binary options trades are up against.
There have been reports of brokers putting their people specifically to monitor traders who are deemed too successful, and to work against these traders to ensure that they do not make any more money.
If you are facing a broker as a counterparty, they lose money if you make money. So what motivation will the broker have in ensuring fairness and transparency in trades?
These scenarios are actually what lead to the price manipulations described earlier in this piece.
Binary Options Robot Scams
The binary options robots scam seems to be the rave of the moment.
Why spend hours losing money yourself, when you could get some automated software to lose the money for you instead? That’s much more efficient, right?
Software programmers have come up with the idea of allowing a binary options robot to perform trades using self-acclaimed successful binary options strategies.
Traders naturally want to know how to win binary options every time.
When they stumble across a binary options robot or binary options signals service which promises to help them do this, it’s easy to get sucked in.
Many of these products are outright scams which do not perform to expectation long-term.
Why You Need to be Wary of Binary Options Reviews
You need to be wary of many of the positive reviews you read about binary options online.
Many of these reviews are written by people who work as binary options affiliates.
Remember earlier on when we told you how much money there was to be made for brokers?
Well, they like to dish out a good percentage of these earnings to affiliates, to help them keep bringing more and more unsuspecting people to lose their money at their brokerage.
What is the easiest method of recruiting a new client to a broker? By simply writing a positive review that hypes up a firm’s services or praises a particular product tied to the opening of a new binary options account.
Once the client gets taken in by the review and signs up, the binary options affiliate is paid. Sometimes they will earn a large chunk of money upfront (up to $250 per sale), whereas other times they’ll actually be incentivised to earn more money – when people they’ve referred lose more money, that is.
Most traders who get sucked in like this are new to the market and do not understand how the affiliate market operates.
Binary options may seem glamorous to trade, but you need to be clear about what you will be facing when you trade binary options. Be wary of the robots, the reviews, the claims and the sales pages. Be wary of binary options; they could ruin your finances.
We recommend risk-free or +EV offers on this site, and take it from us – 99%+ of binary traders will be lifetime losers. Significant losers at that.
Forget copy trading and auto trading.
Do not let a binary options robot trade your account on autopilot.
Always be wary of positive reviews that you read. See if the sites have a real motive to be recommending you to gamble your money away.
Don’t be fooled by images of huge profits.
If you want to make consistent, low-risk money online then you need to start matching your bets.