The difference between forex trading and binary options

Forex vs binary options

Let's explore the differences between binary options and forex trading. The way that binary options work is much easier to understand, accordingly they are better suited to traders who prefer a "light" approach to trading. But don't make the mistake of considering binary options as a financial product for beginners. It is important to approach any type of trading in a serious manner.

Here are a few things to consider to decide whether binary options are right for you.

Psychological weaknesses. Many psychological factors are eliminated with binary options. For example, the impulsiveness and greed that cause traders to stray away from their initial trading plan. Unlike forex trading, you cannot modify a binary option trade once it is initiated. This prevents many trading errors linked to emotions.

Losing more than your investment on a single trade. A binary option has a risk and a fixed return which are known in advance. There is no leverage (a sort of credit offered by the broker), there is no margin. You cannot lose more than the amount invested on the single trade. With forex trading, you can lose more than your investment (your margin) with a single position and the loss is amplified by the leverage a broker provides you with. Options are therefore more appropriate for traders who lack the rigour needed to manage risk and exit trades. Nevertheless, the risk of losing all your money is identical with both the forex and options!

Price movements. With binary options you only speculate on the rise or fall of an asset within a specific period of time. This means that even a difference of 0.1 pip can decide the outcome, unlike forex trading where you have to anticipate a greater price change for an equivalent result. Depending on your strategy and market conditions, this can either be an advantage or a disadvantage.

Time constraints. The expiration of an option after a certain time can complicate the task. A forex trader has the advantage of being able to keep a position open as long as he wants, but on the downside, he must exercise caution in order to close the position with a profit or loss at the right time. Again, options are more suitable for traders who lack discipline or are heavily influenced by their emotions because they don't have to make any decisions once the trade is validated. A disciplined trader who follows strict risk management rules will obtain better results with forex trading.

 

Choosing the best binary options broker

This is not part of the trading process, but it is an important step, because the world of binary options is plagued by dishonest brokers who use very aggressive and deceptive marketing techniques in order to lure naive customers. We suggest that you select a regulated and established broker that also provides services for forex traders (such as ETX Capital) for the following reasons:

1. Prices: You need to know where the prices that are displayed come from in order to be able to compare them, this will give you a distinct advantage in terms of price conflicts (which should be rare with a forex broker that is genuinely regulated).

2. Regulation and reputation: an established forex broker that has a good reputation provides more peace of mind and security for your money than an established binary options broker because regulation of forex brokers is stricter. Binary options are still far from being truly regulated trading instruments. Binary options brokers have a long ways to go to clean up the industry's bad reputation, largely caused by unscrupulous participants.

This doesn't mean that you shouldn't open an account with a broker specialised in binary options, but if you choose this solution you will need to perform a lot more due diligence to assess the broker's seriousness.

3. Demo accounts: this is extremely important. It is still rare to find brokers specialised in binary options that offer demo accounts. Yet it is essential that you start out with a demo account. This is an important item to consider before choosing a broker.

4. Risk Warning: if a broker's website doesn't display any sort of risk warning, stay away from it! If they offer a huge bonus and say that it is easy to double your account in a very short time and without experience, stay away! If a binary broker calls you even though you haven't asked for anything, hang up immediately because it is likely to be a scam. Salespeople who spend their time on the phone are professional liars and manipulators.

 

Comparing risk: forex trading vs. binary option trading

Both of these instruments cannot be fairly compared in terms of their risks, because they work differently and produce different results. The most common criticism against binary options is that you will lose your initial deposit faster than if you were trading the forex. This is false, you can also lose your money very quickly trading the forex. Both of these trading instruments are extremely risky for investors!

The biggest problem regarding binary options' negative reputation is the lack of information that traders are provided with. Options traders have a very limited choice of demo accounts to develop their skills and binary brokers offer little to no educational materials. This is in contrast with forex trading because you can easily find books on strategies and many forex brokers invest resources to educate traders on the fundamentals.

However, forex trading offers greater flexibility in managing risk, because an option's expiration time reduces the amount of possibilities you have to react and adapt the strategy to market conditions. With this in mind, risk in forex trading is lower for disciplined traders who understand leverage and management of positions with rules that leave no room for improvisation.

 

The brokers' business model

Forex trading is advantageous in terms of the brokers' business model, because you can open an account with an STP broker (direct market access, the broker is just an intermediary) that has no conflict of interest with its clients.

The binary options industry is still young. There are no liquidity providers or clearinghouses (except in the US where there are two regulated exchanges, the Nadex and the Cantor Exchange), brokers therefore offset trades internally with a "B-Book". This practice also exists with some "market maker" forex brokers, and depends on customers' profiles, trades are not always sent directly to the market, the brokers can choose to take positions that offset yours. This doesn't necessarily mean that they are dishonest, there is nothing wrong as long as they don't manipulate prices and traders who profit are easily able to withdraw their money.

Nevertheless, it's not a secret, brokers who practice "B-Booking" have a conflict of interest with their clients. When clients lose, binary brokers make money and vice versa. Brokers can afford to do this as the statistics are on their side: most traders lose money.

 

Conclusion

Trading in all its forms requires great discipline. You need to develop and test a trading strategy and develop risk management rules. The risk associated with forex and binary trading is the same - you should only invest money that you can afford to lose.

Regulation of forex brokers offers better protection of your funds, unlike many offshore binary brokers that offer no guarantee on your deposits. STP forex brokers have no conflict of interest with their clients, as opposed to binary brokers who all use a B-Book to "bet" against their clients.

Both trading instruments offer a risk/reward ratio, but binary options allow you to know the potential risks and profits in advance. Binary options eliminate some of the psychological weaknesses that affect traders, but their simplicity prevents traders from using more sophisticated strategies or optimising their investments in real time.

In conclusion, contrary to popular belief, the ease of use of binary options doesn't mean that this type of trading is for beginners, but rather for traders who - despite their previous experiences - are not able to control their emotions when managing their positions. Professional traders do not use binary options because they offer less freedom to develop multiple strategies that are more adapted to the rapidly changing conditions of the forex and stock markets.

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