Binary options trading might sound like a complex, technologically advanced thing to do, but that couldn’t be farther from the truth. If you can understand prop betting in sports, you can understand binary options. (Note to self: Don’t lose money this year betting on whether the winning Super Bowl quarterback will cry during the post-game broadcast. I thought Peyton Manning would for sure shed a tear last year.)
How Binary Options Trading Works
The word binary means “something which has two parts.” In the context of binary options, this means you’re looking at an asset (say, a stock price) and trying to determine one of two things: Will it be above a certain price at a certain time, or below a certain price at a certain time?
For instance, if you’re sure that Apple’s next iThingy is going to take the world by storm, you might want to place a bet that their stock price will go up. Here is a hypothetical example of how this could play out:
If AAPL is currently trading at $100 on a Monday, you can place a bet that on Tuesday at 12 p.m. their stock price will be above $101.
Then, as implied by the binary moniker, you can either win or lose this bet. The stock can be trading above $101 at 12:00 p.m. on Tuesday, at which point you will have won however much money you wagered.
Alternatively, maybe Apple CEO Tim Cook trips over his shoelaces and falls off the stage during the presentation of the next iThingy, causing investors to fear that Apple has shaky leadership. The stock price drops to $99 at 12:00 p.m. on Tuesday, and you lose the money that you wagered.
It’s as simple as that. Instead of gaining or losing a dollar and change per share owned as an APPL shareholder, you win or you lose your entire bet on that single outcome (and remember that the broker gets a cut either way). This is why people sometimes refer to this style of betting as “all-or-nothing trading.”
It’s important to keep in mind that while this style of trading is high-risk, high-reward, binary options are not a scam. If you trade with a reputable institution, you’ll be given a fair shake. Your payouts will be prompt and you can trust the company with your banking information.
But… Watch Out for Scams
Unfortunately, at this time there is only one reputable, U.S. based website that is certified by the US CFTC (Commodity Futures Trading Commission) to trade binary options, and that is nadex.com. So, if you’re going to trade these options, make their site your first stop.
But, there are other options. The CFTC lists all of the sites that allow options trading but are currently unregulated. Not all of these sites are engaging in criminal activity, mind, you — but you’re playing a riskier game if you trade options without doing your due diligence.
Scammers also realized long ago that investors who have an appetite for binary options are ripe to be deceived. This has led to several cases of fraud. Things got so bad that in 2013 the SEC felt it necessary to release a report warning people that many of the companies that show up when you Google ‘binary options brokers’ are going to be run by scammers. The report notes that, “These schemes allegedly involve, among other things, the refusal to credit customer accounts or reimburse funds to customers, identity theft, and manipulation of software to generate losing trades.”
If that doesn’t deter you from investing your money with an unregulated broker, there do appear to be some decent options out there: BinaryOptionsBlacklist.com gives their relatively trusted seal of approval to sites such as 24option.com, TR Binary Options.com, and BetOnline.ag. For what it’s worth, these sites are mostly based in Cyprus and Panama, countries with notoriously lax regulations.
Should You Be Trading Binary Options?
We here at the Simple Dollar are all about low-cost, buy-and-hold investment vehicles, such as index funds. Trying to beat the market is generally a fool’s errand, and those who make you think it’s fun and easy to do so are likely looking to make money off you in the form of fees.
It’s illuminating to realize that even nadex.com, the most highly regulated binary options trading site, asks their readers to “get in on the excitement of a limited-risk, low-cost way to trade the financial market.”
Excitement? Gambling is exciting. Skydiving is exciting. Most people aren’t going to benefit by getting their adrenaline fix from the financial markets. A “get-rich-quick” mindset leads to risky speculation and knee-jerk reactions, two things you want to avoid at all costs when it comes to building wealth.
You will likely be better off making an investment strategy, diligently saving for retirement in low-cost funds, and staying the course. Boring is better when it comes to investing.
While binary options trading is legal, simple to understand, and potentially quite fun, its inherent volatility means it’s not for the feint of heart — nor the sensible investor. This kind of trading should probably be looked at more as a form of gambling than a way to build your nest egg.