A binary option is a financial product or instrument that allows traders or investors to speculate on the price movement of an asset. Prices of assets such as stock, crypto, commodities, and so on are predicted to move upwards or downwards at a specified period.
This prediction will mean that traders will either earn some money on their investment if their predictions are correct or risk losing their investment if they are wrong. Winning or losing depends on the outcome of “yes or no” predictions, hence, Binary Options.
Having understood binary options and their high returns and high-risk characteristics, why have they considered the best choice for a beginner? This is because:
- It is simpler to understand and trade compared to traditional options. In just a paragraph, I have been able to paint exactly how binary options work, making it easy for any beginner to hop on.
- There is a low entry barrier with binary options trading. It is easy to understand, but traders only need massive capital before trading.
Basics of Binary Options Trading
Understanding binary options trading will involve learning the basic concepts of some types of binary options and some terminologies used by binary traders.
Some of the most common binary options are:
- Call options
- Put options
- Touch options
Types of Binary Options
Call Options: A call option is a bet or prediction that the price of an underlying asset will rise above its current price. A call contract gives the trader the right to buy the asset at any point till the contract expires.
Put Options: Differing from the call option, a put option is employed when the trader predicts that the asset's price will fall below the current price. A put contract gives the trader the right to sell the asset at any point till the contract expires.
Touch Options: Touch options are used by traders when they believe that the price of an asset will touch a fixed price at a particular timeframe.
Other Terminologies In Binary Options Trading
- Current rate: This is the current price of an asset.
- Broker: A person or company providing traders with a platform to trade binary options.
- Range Option: A specified limit by organizations for different zones.
- In-the-money Options: A situation where the trader correctly predicts the movement of the asset’s price, thus making a profit.
- Out-the-money Options: A situation where the trader incorrectly predicts the movement of the asset’s price and makes a loss.
- Expiration Date: The exact date and time when the option will be settled for cash. Expiration dates can range from as short as 60 seconds to several months.
As a beginner trader, it is essential to learn some trading strategies. Although simple, binary options can be risky if not properly strategized. Some of the most popular strategy used by traders is explained below.
Technical analysis is an overall trading strategy with binary options. It involves analyzing price charts and using technical indicators to predict market movement based on previous patterns and trends in the asset’s market. These indicators provide insights into future market movements. Some of the most famous are:
- Moving average
- Moving true range
- Moving average convergence/divergence
- Relative Strength Index
Fundamental analysis is a trading strategy that involves studying and analyzing real-world factors affecting an asset's price.
Internal and external factors such as economic indicators (such as interest rates, inflation rates, etc.), financial policies, political policies, news and events, and companies’ financials all play essential roles in influencing the prices of assets. A thorough study and analysis of these factors can provide insights to traders on how best to trade.
This is the most common strategy or rule in trading. Traders are never advised to trade against the trend. This strategy works by identifying the market's direction and trading in one order at a time.
This strategy involves identifying the key levels where there is support and resistance in the market and entering trades whenever prices break through the support and resistance levels. This strategy is best employed in markets with a trend of trading within a given range because those markets have highly defined and strong support and resistance levels.
This strategy works best in highly volatile and uncertain markets. It involves using call-and-put options to guide against making losses. Out-of-the-money put options are sold simultaneously as out-of-the-money call options are bought. This protects against losses and still leaves a possibility of gain.
Risk And Money Management
Having established that binary options trading is risky, another key concept to understand is risk and money management as a trader. It is essential to manage your bets so that:
- You can achieve minimum losses
- You can protect your portfolio from losses that may end your trading career.
Setting Up A Risk Management Plan
Setting up a risk management plan can assist you as a trader in having a “rule book” that you follow religiously when setting up trades. You should do a lot of research on risk management before setting up a plan. You should consider other factors such as your risk appetite, expected time of returns, and so on. Some general tips for setting up a risk management plan are:
- The investment amount should be based solely on your risk appetite: You must determine what percentage of your portfolio you are willing to risk and stick to it. Overtrading or under-trading may leave you with unforeseen losses.
- Set a realistic daily goal for yourself: Determine what percentage of your portfolio staked you would like as returns. Your expected daily returns should be fair and realistic. Over-expectation may lead to disappointments, while under-expectation may make you inefficient.
- Set a limit for daily losses: Set a limit for what percentage of your portfolio you’re willing to lose in a day and stick to it. If you have not met your daily goal, stop trading once you hit your daily loss benchmark.
- Stick to a trading strategy: Trying out several strategies without being consistent with anyone can make you lose a lot of money.
Money Management Strategies
Money management is how traders manage their total investment capital or portfolio. Combined with risk management, they allow traders to minimize losses in a hazardous binary options trading environment.
Some of the most popular money management strategies are:
- Percent rule: This involves setting a fixed percentage(e.g., 3%) of your total portfolio to be invested in a trade. For beginners, it is recommended to stick to 1% per trade. As your experience and confidence as a trader increase.
- Calculating and setting pre-defined risks: Similar to the tip from risk management, it is essential to set a fixed percentage of loss allowable before trading.
- Kelly Criterion: Developed by John Kelly, the Kelly Criterion formula helps to calculate an optimal bet size. It is similar to calculating probability. The formula is F + (bp-q)/b, where:
- F is a fraction of the current portfolio
- b is the net odds to be received on the trade
- p is the probability of winning, and
- q is the probability of losing
- Broker: It is essential to find the best broker available. A perfect broker will have the maximum pay-out amount and minimum charges.
A very common pitfall among traders is allowing negative feelings or emotions to determine how they trade. A common rule is that “trading and emotions don’t go together.”
Some of the most common mistakes beginner traders have made are:
- Fear: Frequently, traders give in to fear when trading. This is expected because trading involves many risks over your money, portfolio, or assets.
- Frustration: Fear and frustration come in, and a frustrated trader is a recipe for wrong decisions.
- Greed: Generally, being greedy is a bad trait. It can make you take unreasonable trades and end up with many losses.
Techniques For Managing Emotions
Some of the most popular techniques used by various traders to manage their emotions are:
- Discipline: To be a successful trader, you must stick to your risk management and money management strategies and always stay within them, even in the circumstances. This will prevent you from being greedy and falling for silly baits.
- Leave emotions: Endeavor to make it a habit to leave emotions at the door before you begin to trade. Do not trade while you’re emotional, and avoid trading under pressure.
- Today's rule: To develop a disciplined habit, you may consider tricking your brain into believing you will “stick to the rules for only today.” Sticking to the rules “today” daily helps develop better habits.
- Trade step by step: Sticking to your trading plan and following it step by step is essential.
- Make a list to define your goals.
Binary options are straightforward. It is simply a bet of yes or no. This makes it very risky for a beginner. You must learn about reasonable trading strategies and techniques.
You must also always make a trading plan, a risk management plan, and a money management plan. Sticking to the rules mentioned in this article and managing your emotions properly will set you up as a successful binary options trader.
You must be 18 years or older to trade binary options. Your broker would request a valid ID before an account is opened.
It is possible to trade binary options without investing. You have to open a free demo account.
There are no sure strategies that guarantee wins. All strategies involve speculation.
There is no fixed maximum payout amount. Your winnings depend on how much you invested and the correctness of your speculations.