This article does not present an absolute declaration of one market being better than another. It simply represents the views of someone who has traded both markets and is therefore a reflection of experiences in the context of what is obtainable in these markets today.
What is Forex Trading?
Forex trading is the practice of buying and selling currencies with the expectation of making a profit from the change in the rates of exchange between the point of first exchange and the point of re-exchange. Currency changes are forever changing on a second-by-second basis, especially during periods when the major trading hubs have a time overlap. Therefore, it is possible to make money from the exchange rate differential which occurs.
What Are Binary Options?
Binary options trading is a form of investment where the trader is presented with two possible options or outcomes for an asset, of which only one can be correct within the allocated time for the trade. If the asset behaves according to the choice made by the trader, a profit is made. If not, the investment is lost.
What are the Differences Between Forex and Binary Options?
There are many online resources out there which will try to get into an argument over which of the two forms of trading is better than the other. Without trying to join this argument, here are the facts about both markets.
- Returns on Investment
Forex is a market with variable returns; the more pips in profit territory your trade is, the more profit you make. The reverse is also true; the more pips in loss territory your trade is, the more losses you make.
In contrast, binary options present fixed returns; your payout for a profitable trade is fixed irrespective of how many pips the trade has moved in the trader’s favour. However, losses are capped to whatever was invested in the trade; nothing more. This can also be an advantage for the trader, as only one pip in the right direction is required to get a full payout.
- Risk vs Reward
It is a well-recognized fact in forex that being able to search out trades where the reward far outweighs the risk is the secret of market longevity. This is where forex trumps binary options. In forex, it is possible to get trades that provide a return of 3 pips for every 1 pip risked. Assuming the risk levels used in all trades are the same, it would take three losing trades of the same magnitude to wipe out gains made from a trade with a reward-risk ratio of 3:1.
In binary options, returns are fixed. Profitable trades only pay out 65% to 80% profit. Losing trades result in 100% loss of the invested amount. So one winning trade and one losing trade will not only erode the profit from the winning trade, but also leave the trader with less money than before.
So when it comes to making money from trading, fixed returns may not actually be the best way to go about it.
- Leverage/Margin Requirements
Forex is a leveraged market. The movement of currency pairs is so small that the trader needs to borrow from the broker to be able to control the large positions required to make reasonable returns.
With binary options, this is not the case. Binary options are unleveraged instruments. A trader must invest the full amount required for the trade whenever this is carried out. This provides greater financial burden on the trader if financial goals from trading are to be achieved.
The forex market is a well-regulated market with lots of brokers who stick to the rules most of the time. The rules defining forex are well defined in jurisdictions where currency trading is regulated. Binary options are still for the most part, not properly regulated. This has opened the door to many brokers who perpetrate dodgy practices in the market. You are therefore more likely to find shady brokers in the binary options market than in the forex market. Extra vigilance is needed when looking for a binary option broker.
- Automated Software
Both markets now boast of the presence of automated trading software or trading robots. Forex traders have the advantage of being able to host their expert advisors on remote servers (forex VPS). Binary options software are mostly web-based and cannot be hosted on VPS. This means that binary options traders must depend on their local computers being connected to the internet without downtimes to be able to trade effectively.
- Choice of Assets
The binary options market is a one-stop shop for trading all asset categories. This is an advantage for traders who know how to trade correlated assets. This is where binary options trump the forex market.
- Trade Types
Trading forex can only be done by buying or selling a currency pair; your profits depend on whether the movement of the currency pair are in your chosen direction. In binary options, you can make money from other ways apart from just buying and selling an asset. For those who do not like to be constrained to doing the same thing over and over again, the other trade types found in binary options provide an alternative way of going about trading business.
As mentioned earlier, this article is not about trying to prove that one investment vehicle is superior to the other one. It is about presenting the facts of the two markets as they are, so that traders will be better informed about the structure of both markets and make a choice of which market will suit them better.