Is it Forex or binary options? 7 things to know before making an investment
Differentiating between Forex and binary options trading is essential to becoming a successful investor. Seven key differences make it easier to understand the two financial instruments.
According to research, 25% of traders find it difficult to distinguish between Forex (some notable Forex brokers include OctaFX, AvaTrade, and FXTM) and binary options, while 14% think that they are the same. After all, they share similar charts, indicators, and trading instruments. However, these two financial instruments are completely different.
What is Forex?
Forex is the largest and most liquid market in the world. Major financial institutions, banks, and investment management companies use Forex to exchange and trade currencies. Anyone going on holiday to another country participates in it as well by just buying the currency of that country.
Currency rates are changing every day. One can see it by simply looking at the screens in a currency exchange office. If one buys a currency today, and its price increases tomorrow, one can sell it and make a profit. That’s exactly what Forex traders do—although with a more complex set of tools—following the price movements in real time.
When it comes to binary options, the process is quite different.
How do binary options work?
Some talk about ‘trading’ binary options. That is not exactly true. Rather, most people use binary options as a gambling machine. There are only ever two options—that’s where the name comes from—in such a roulette: the price going up or down during a fixed period of time. For instance, if one bets 100,000 rupiahs on the EUR/USD value to go up in the next 5 minutes, and it goes up, one will get the 100,000 rupiah bet plus up to 80% premium, that is, 180,000 rupiahs total. However, if it goes down, one will lose 100% of the money one put in.
As for the differences between the two financial instruments, they are presented below. Investors may use them to understand whether they are dealing with a Forex broker or a binary options provider when starting investing online.
In Forex, investors can open trades on currency pairs and hold them for as long as they want. During that time, the price may go down below the level at which they entered the trade and then go up after some time. The trade will still result in them profiting. Even if the price stays down, it’s unlikely that they will lose all the money they put in the trade.
In binary options, if the price goes down and doesn’t recover before the option’s expiration time, the binary options’ users will lose the money they put in the bet.
2. Profits and losses
In Forex, the mechanism behind profits and losses is transparent. It is almost the same as buying physical currency and selling it the next day with a profit.
In binary options, it is unclear how profits and losses are calculated. The closest example of how it works is, again, betting. A binary options user gets betting odds that are based on expiration time and instrument of the option, as well as some other unknown parameters. These odds are usually less than 80% of the money users bet. Yet, when they lose—they lose 100% of it.
3. Risk management
In Forex, traders can manage their position while it’s open. They can also manage risks by setting stop-loss and take-profit orders that will close the trade once the price has reached a certain level of profit or loss.
In binary options, there is no way of altering the bet when it’s open. Should one close it before expiry, one will lose the bet entirely.
4. Margin trading
Using leverage, traders can open positions with volumes far exceeding their initial investment capital, allowing for a much lower barrier of entry into the Forex market. Margin trading is not available for binary options.
5. Types of orders
While Forex traders can set up to 10 order types in the renowned MetaTrader platforms, adjusting their strategies and entering or exiting the market at a predetermined time, binary options users, in most cases, have only two types of orders available. All they can do is to bid on the price rising or falling.
While the Forex market is subject to regulation and many brokers around the world possess licences issued by financial authorities, binary options are illegal in many countries, including India.
7. Conflict of interest
In most cases, Forex brokers send trades made by their clients over to the interbank market, where they are executed. The Forex broker does not profit from the losses of its clients. On the contrary, it is interested in them to succeed since that often means they will trade more and bring more money in trading fees.
Binary options providers do not send the trades anywhere. What do they profit from? Their clients’ losing bets, just like a betting company. Such providers make money on losing bets, are not subject to any regulation, and do not channel the trades to the broader market for execution. These facts create a conflict of interest, which is not a desirable way of financial cooperation.
Knowing the risk and reward of a ‘trade’ beforehand does not make binary options a safer instrument. It’s the fixed expiration time, the profit/loss mechanism, and the lack of variability of order types and risk management techniques that put the investor’s money at greater risk.
Since binary options providers are aware of the questionable qualities of their products, many of them try to make their offerings look more trustworthy by adding Forex trading as an additional feature. Traders should understand the danger these providers may pose to their capital. Such ‘binary-options-and-forex’ companies undermine the credibility of the Forex industry as a whole by bringing the two completely different financial instruments together, with one of them having all the characteristics of gambling activity.
Forex-only brokers in India include OctaFX, Exness, and XM and should be considered intermediaries between potential investors and the interbank Foreign Exchange market.