Forex and binary options are primarily the same products from the broader financial markets spectrum, however, their similarity ends there. For traders who contemplate whether to trade forex or binary options, this article aims to present a clear picture of the difference between forex and binary options.
Binary options, or ‘Options’ as they are often referred to, fall under the category of the derivatives markets. The derivatives market is made up of financial products whose value is derived from the actual market. Other examples besides options include ETF’s, Eminis which although similar are not exactly the actual products that you trade, but are products designed to reflect the actual security.
Similarly, when comparing forex to binary options, the binary options (for forex) are derived from the spot forex markets and similarly, binary options for equities (stocks), commodities and so on are derived from the actual stock market and commodities futures markets respectively.
Although binary options are derivative in nature, it doesn’t change the way they are traded. Therefore, binary options and forex are speculative in nature where traders make money from the rising and falling markets.
Main Differences between Binary Options and Forex Trading
When it comes to trading binary options or forex, there are some main differences between the two as outlined below.
Trading Approach: With forex, speculation is based on buying (or selling) at a certain price and exiting (closing the trade) for a profit. For example, with forex, it is as simple as buying Euro Dollar (EURUSD) at 1.30, and selling (closing the trade) at 1.31 to make 100 pips in profit. With forex, a trade is considered successful when it reaches its target price (or as long as price is above your buy price or below the level of your sell price).
With binary options, there is no ‘target level’ to achieve, but rather the direction within the constraints of time. For example, a CALL option is considered to be ‘in-the-money’ (successful) when price is above your entry price within the time period of the options expiry time.
Leverage: Leverage is a common feature when it comes to the forex markets. Due to the minute price swings (known as pips), a trader, unless having a trading equity of 1,000,000 the profits are miniscule. Leverage allows traders to magnify their trading accordingly and thus makes it easy for a trader with $100 equity to trade in the likes of mini lots (0.1 or 10,000 units).
Leverage is virtually non-existent with binary options. This is due to the way they are traded (refer to the ‘Trading Approach’ section above to know why).
Risks: There is a lot of marketing hype that makes one to believe that binary options are fixed risk. Spot Fx traders would know that by setting a stop loss level, they too can limit their risks. However, the main difference in regards to risk with binary options or forex is that, in binary options, the amount you can lose is always equal to the amount you invest. In forex, the amount you risk depends on how close or far your stop loss level is set to and therefore, the risk can vary.
Forex and Binary Options – The Business Model
Another aspect worth noting is the business model of forex and binary options brokerages. At a very broad and simple level, forex business model is where your wins and losses become another trader’s losses or wins. For example, an ECN forex broker would simply charge commission on your trade. When you win a trade, the amount of profit you make basically comes off other trader’s losing positions (to keep it very very simple).
With binary options, trading is done mostly against the binary options broker. Therefore, it is easy to see that in order for the binary options broker to remain in business, they need to have traders who keep losing consistently or they would end up having to pay the 81% profits from their pockets.
However, this should not be alarming because the binary options brokers don’t really need to rig the prices. The basic facet of ‘greed’ does a job good enough to ensure that the brokers always have more losing traders and than winning traders.
Forex or Binary Options?
This brings us to the question of which is better… Forex or binary options?
Well, honestly there is no right answer to this and it is purely subjective and based on a trader’s specific risk tolerance, trading approach and so on. It would be worth mentioning however that most traders (including Forex, Equities, Futures) do look to options as a way to hedge potential risks. While trading binary options alone can be profitable, the advantage of options is perhaps best reflected in their ability to help traders in hedging.