Are Binary Options A Sensible Way to Trade?

I've been looking at Binary Options as a way to trade BTC recently. Most binary option providers offer the opportunity to trade BTC and they promote binary options (or digital options) as a safe and easy way to trade almost any financial instrument. But there's also a ton of fluff and hype especially about the returns being as high as 85%. But is this true?

Choosing A Binary Broker

The SEC and Canadian Securities Commission have warned on fraudulent binary option broker practices - the worst of which are manipulating expiry times in the broker's favour and delaying, or in some cases refusing, withdrawal of trading profits. In the world of dodgy Bitcoin exchanges, perhaps this risk isn't too alarming but choosing a reputable broker, you can avoid unnecessary risk to your capital.

Who ever heard of a casino going bust? The binary broker will win on average, they have the house advantage, it's just a question of how fairly they intend to treat their customers in the pursuit of profit. Or are they in a hurry and look to 'churn and burn' their clients?

Before signing up to a broker, check out their offerring, make sure they trade bitcoin and check their reputation online. In the US, NADEX is the only official US binary exchange but in Europe & UK, there's weak or no regulation of binary brokers. So do check to see if a binary broker is a member of any half decent regulator - some regulation is clearly better than none. Not all brokers peddle the myth of high trading success rates, high payouts with less risk. So I am leaning towards those binary brokers who use less hyperbole and are more real.

I hope to share my experience in talking to binary brokers. I am launching a new binary options trading signal service on FX to test the waters (sign up to find out more). It's a bit time consuming at the moment but should run smoothly by mid-week.

The fun bit is all the dodgy maths on the websites and winning systems that are everywhere. Some system providers are suggesting that certain trades have a 100% chance of success. I have asked for the calculation details of the published odds of winning. The answer will be very interesting!

Anyhow, back to binary options. What's the pros and cons of this trading instrument?

PROS

In a survey conducted by FXCM, over 12 million retail currency trades were examined to reveal the Traits of Successful Traders. The analysis revealed some interesting results:

• retail FX traders are RIGHT more than 50% of the time;
• the most commonly used strategy is 'range trading'
• traders perform poorly in volatile London and New York sessions;
• the main cause of poor profitability is bad risk management.

So binary options would seem to be an instant cure for most traders because the risk of the each trade is limited to the stake. But the payout is often no higher than 70% which means that this is not a fair game. Therefore you need a strategy that must win on average 60% of the time to expect positive returns. According to FXCM, retails traders are right at this level for a few currency pairs so why don't FX traders abandon traditional trading platforms and head over to binary options in huge numbers? Why wrestle with the tricky issues posed by volatility, stop placement, trade size and order type.

The main advantages of binary options for trading are:

1. binary options will pay out if your trade wins by 1 pip (less if they use 5 decimal places) or 50 pips so that removes many issues relating to volatility which BTC is prone to from time to time;
2. the risk in a binary options trade is fixed at the outset. Its limited to your stake;
3. binary options can be used for a large number of strategies but for shorter expiry, momentum & trend based systems work best;
4. placing a binary option trade takes a few simple clicks - select asset, select call (up) or put (down), select expiry and click to approve the trade;
5. you get great leverage to amplify your returns.

Trading binary options seems to offer a simple fix to all the ills discovered in the FXCM survey that cause retail traders to be losers. But you don't just need a strategy that's right on average 60% of the time, you also need money management. And that's where we head over to the Casino and take a look at the Martingale.

Casino odds are biased in favour of the house - this bias is small but over a very large number of transactions, this edge is very valuable. So the Martingale betting strategy is used by gamblers to recover their initial stake after experiencing a series of losing transactions.

Imagine a colleague of yours tells you he's found a roulette gambling system and he wins GBP 100 every day. He tells you that as he walk home, he pops into a Casino and bets red at the roulette table.

You decide to witness this because it doesn't seem possible to make GBP 100 every day - after all if it were true, everyone would do it. You go with your colleague a few times and watch him place the bet: he stakes GBP 100 a few times wins his GBP 100 straight away, sometimes he loses but makes the same bet again but as he does so, he doubles the stake. But he always walks away with GBP 100. This is genius and you wonder if you should join in with the action. Then one day your colleague comes into work ashen faced, dishevelled. He tells you that he is ruined! A rather odd statement from someone who makes GBP 2,000 a month extra income, tax free for little effort you think but, concerned, you ask what has happened. He tells you that an extraordinary thing happened - after 10 losses in a row, he simply could not afford to stake another bet of GBP 204,800 and lost his life's savings. And that's the impact of long tail risk associated with this betting strategy - eventually it bankrupts the gambler but it can a jolly nice, long ride to penury!

But in financial markets, stock returns are serially correlated so "streaks" of wins or losses do happen more often and are longer than those under a purely random process. An anti-martingale strategy could theoretically be applied and can be used in trading systems (such as trend-following, momentum, break out strategies). In an anti-martingale betting strategy, the stake is doubled after a win and reduced after a loss. I don't have any experience of this betting strategy yet and will report in due course.

CONS

The disadvantages of binary options are that:

1. its not a fair game but I guess brokers have got to eat too ;)
2. the more you trade, the more the probability of a 'bust streak' of losses rises;
3. you need adequate capital to survive a small losing steak;
4. trade success is determined at expiry. Not before or after.

It troubles me that, having disposed of the problems arising from price volatility, stop placement etc, I now have the problem of assessing whether my trade will be successful at a specific time. This narrows down the strategies and instruments you can profitably use but it still leaves BTC on the list.

Trend following strategies have been successful in the past with BTC (remember ButterBot?) so, on the face of it, binary options are sensible, easy way to trade BTC and you have the additional knowledge that if another exchange blows up or draconian legislation is passed, your risk is fixed. After all, if you got caught up in the hype and froth surrounding BTC prices as they rose to USD 1,200 and went long, you're a long way down and need prices to rise 240% to get back to break-even. Perhaps the explosive returns associated with binary options trading could fix your recovery? It's your decision.

For me, I am going to try binary options - there's no demo platforms so the only way is live, baby! My risk will be fixed at the deposit I place in the account and, like my experience at Plus500, I may get a trading bonus to further reduce risk. I am interested to establish actual average payout rates and to try some betting strategies.

You've gotta be in it to win it.