Binary Option Definition: Day Trading Terminology.
Over recent years traders have started hearing about a new trading product, but there’s a lot of questions and concerns about what they are and how they work. Binary Options are a type of derivative that are considered an “all-or-nothing” asset and is comparable to placing a bet on a sports game.
When you purchase a Binary Option you either make a predetermined amount based on how far out-of-the-money your option is or you lose your entire investment at the time of expiration. There is no in between and is why they are called “binary”, because there is only two outcomes.
Binary Options are similar to normal options in that they are expiring assets but they are very different in just about every other aspect. You cannot buy one and sell it back at a higher price if it trades in your favor.
You have to wait till the expiration to collect your winnings or realize your loss. Traders have found them attractive due to their simplicity but given their lack of regulation by the Securities and Exchange Commission (SEC) they tend to carry more risk and may not be suitable for everyone.
How They Work.
When you buy a Binary Option you must predict where a stock, ETF or index is heading within a specified time frame.
So, for example, if the SPY is trading at $225 and you think it will close the day above $226 you would buy the binary call option at that strike and if the SPY closes above $226 then you will receive your winnings. However, if it does not finish above $226 then you will lose your entire investment. It’s as simple as that!
Binary Option Pros & Cons.
Binary Options have both good and bad qualities about them. What I really like about them is that they take the emotion out of trading. You buy it and wait till expiration and either collect your winnings or accept your losses.
I also like how simple they are to trade and that you’re risk is limited to only the amount you invest. If you have ever traded normal options then you will have no problem trading Binary Options.
However, what I don’t like about Binary Options is you can’t cut losses if the trade is going against you and you’re susceptible to whatever news comes out during your time till expiration.
I also don’t like the fact that it is not accepted by all brokers or exchanges or regulated like normal options making them a riskier product. However, they may become a mainstream trading product one day so familiarizing yourself with them may be a good idea.
Warrior Trading Pro Tip.
Binary Options are generally unregulated and are more prone to fraud. Unless you completely understand and accept the risks involved then I would recommend sticking to regular options or stocks.
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Available research data suggests that most day traders are NOT profitable.
In a research paper published in 2014 titled "Do Day Traders Rationally Learn About Their Ability?", professors from the University of California studied 3.7 billion trades from the Taiwan Stock Exchange between 1992-2006 and found that only 9.81% of day trading volume was generated by predictably profitable traders and that these predictably profitable traders constitute less than 3% of all day traders on an average day.
In a 2005 article published in the Journal of Applied Finance titled "The Profitability of Active Stock Traders" professors at the University of Oxford and the University College Dublin found that out of 1,146 brokerage accounts day trading the U.S. markets between March 8, 2000 and June 13, 2000, only 50% were profitable with an average net profit of $16,619.
In a 2003 article published in the Financial Analysts Journal titled "The Profitability of Day Traders", professors at the University of Texas found that out of 334 brokerage accounts day trading the U.S. markets between February 1998 and October 1999, only 35% were profitable and only 14% generated profits in excess of $10,000.
The range of results in these three studies exemplify the challenge of determining a definitive success rate for day traders. At a minimum, these studies indicate at least 50% of aspiring day traders will not be profitable. This reiterates that consistently making money trading stocks is not easy. Day Trading is a high risk activity and can result in the loss of your entire investment. Any trade or investment is at your own risk.
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