Binary Trading should be re-named Probability
Trading..
In truth Binary Trading is an appalling name for something that
is such a simple concept. Think of binary trading as
probability trading. The binary market maker will pose a
question that will have two possible outcomes. Either the event
happens or it doesn't. The market maker with then make a price
around this.
So how does it work?
For example, it's 9.30 am and the FTSE is trading at a price of
5760 and a binary market maker is asking 'do you
think the FTSE will finish above 5750 by 12pm today?' and it
will give a price, or probability, of this happening. This price is
displayed as a percentage and so in this example the market maker
may give you are price of 60-65 for the FTSE to finish above 5750
by 12pm.
This means the market maker believes there is a 60-65% chance
of the event happening. If it does, the bet settles at 100% and if
it doesn't it settles at 0%; it's as simple as that.
In our example if the FTSE finished at
5751 at 12pm the answer to the original question of 'will
the FTSE finish above 5750?' would be 'yes'. A trader who
bought the price at 65 would win the difference between 65 and 100
(times the stake of the bet) and a trader who had sold at 60
(believing that the event wouldn't happen) would lose the
difference between 60 and 100 (times the stake of the
bet).
So let's suppose we decide to trade for £5 per
point our potential profit and loss would be as follows:
Buy £5 at 65 and event happens (so market
settles at 100) wins 100-65 x £5 = £175.
Buy £5 at 65 and event doesn't happen (so
market settles at 0) loses 0 - 65 x £5= -£325.
Limited Losses makes this an appealing product
The increased interest in this product is due to the limited loss
for each bet placed. If we look at the example once more and
consider that, due to some disastrous economic news, the
market at 12pm is actually trading at 5600. The
binary trader predicting the price would finish above 5750 would
lose 65 times their stake whereas a futures trader or spread bettor
could be facing losses far greater.
Low market volatility doesn't matter
Spread betting, CFD, FX and Futures trading all require
volatility in the underlying markets for traders to make profits.
It becomes difficult to make money when markets have a narrow range
when using these products but the binary markets always have
volatility. So why is this?
Let's go back to our example above. If you were trading using
spread betting and the FTSE had a very narrow range of 10
points around 5750 (okay, this is unlikely but at certain
points of the day it can and does happen) it would be
difficult to make money after paying the spread betting
providers spread.
The binary market however would be constantly moving. Remember
the original question the market maker asked, will the FTSE finish
above 5750 by 12pm? If the market is moving in between 5745 and
5755 the binary price is going to be swinging wildly to reflect the
probability of the market finishing above or below 5750
giving you plenty of opportunities to trade and
potentially make good returns from what would ordinarily be
a quiet market.