June 12, 2021


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What Are Binary Options and How Do They Work?

9 min read

In search of a good opportunity to make profits with existing capital, more and more traders are betting on binary options. As a relatively young financial instrument, binary options have become increasingly established in recent years. But what exactly is meant by this term, how does trading work, and what to look out for in the search for a broker? You need to know all this, so that you don’t fall in the hands of a black sheep as in the binary options industry, there are many fraud brokers.

Binary options, or digital options, are novel financial instruments that enable traders to benefit from both rising or falling prices. Unlike traditional options, binary options can be traded with very little capital, making them particularly interesting for newcomers.

For binary options, you can set to Call (rising price) or Put (falling price) option
Option durations can range from 30 seconds to one year
Most commonly, returns between 60 and 92 percent are possible
Losses are limited only to the respective use, with many brokers offering 15 percent as a hedge
Volatility strategy and trend following strategy can make trading more effective

How do binary options work?
Best Binary Options Demo Account
High returns and calculable risk
Different types of trading and additional functions
What to pay attention to when trading binary options
The Conclusion

How do binary options work?
The term “binary” signals the simple functional principle of these trading instruments. An option can only accept 2 states, “in the money” and “out of the money” – similar to the digital states “1” and “0.” It only depends on whether the option is in the money at the end of the option term (expiry date) or not.

If a trader suspects a rising price, he buys a call option. Put options are set accordingly to falling prices. For the positive conclusion of a trade, the price at the end of the term must therefore be higher (call option) or lower (put option) than at the time of entry. The trader therefore only makes a directional decision regarding the price development of a particular asset in binary options trading. This asset acts as a so-called underlying for the binary option. In the chart, the forex currency pair EUR/USD is the underlying of the option.

The price of the underlying at the end of the option term is therefore crucial to whether the trader earns money. If the trader is correct in his market assessment, the option is “in the money” at the end of the term and a predefined return is paid by the broker. Depending on the supplier, this is usually between 62% and 92% of the stake in traditional trading. In case of loss, many providers offer a repayment between 5% and 15% as a hedge. Trading in binary options is usually possible from stakes of 10 to 25 dollars per trade.

Even though it may sound like binary options do not require experience and that you always make money, losses are possible, sometimes, traders lose total capital. Therefore, it is recommended for beginners, to first, without the use of capital, test trading to get a picture of the binary options trading. For example, they can do this with a demo account with almost all brokers. The best brokers can be found in our broker reviews section. Simply choose a provider and create a demo account.

Trading binary options is basically easy to understand. The trader does not bet on an asset, but rather on the corresponding performance of the underlying. Here, the trader decides whether he expects, for a put option, a falling price of the underlying and vice-versa. If he is correct at the end of the option term, he will achieve the respective yield. However, it is important to have a good broker on hand where trading gets along well.

Even though the binary options trading is very easy to understand, the success of traders heavily depends on the broker. In our broker reviews, there is a helpful overview of the best providers. The IQ Option demo account proved to be the winner of the Best Binary Options demo account award. You should look for such a provider if you want to learn how to trade binary options.

Some advantages of the IQ Option demo account:
Demo account is 100% free of charge
Many assets are freely tradable
Interface is intuitive and suitable for beginners
Support is available
Account can be created in just few minutes

Below are some more details about this broker:
Minimum deposit of just 10 USD/GBP/EUR
Regulation by CySec
Different options to choose from
30/60/120-second trade possible
Up to 50% new customer bonus
Mobile trading possible
Numerous underlyings in different asset classes

With things like a minimum deposit of just 10 USD, IQ Option is a very good broker option for traders who want to test everything. If you have left the demo account behind, bets can be made from 1 USD per trade. Thanks to the vigilant support and the many interesting courses, you can also continue your education individually at any time.

The bonus program of IQ Option is based on the existing customer principle and depends on the respective deposit amount. For a deposit of 10 USD you get a 25 percent bonus, or $3 for free. The maximum sum of $10,000 would bring a 50 percent bonus, or $5,000. The bonus can be used with every deposit!

High returns and calculable risk
The risk of binary options trading is always limited to the selected amount in your bet. For IQ Option, for example, the least amount would be just $1. There is no premature stoppage due to short-term price fluctuations, such as in stock, CFD, or forex trading. It does not matter what the price of the traded asset is during the term. Only the current price at the point in time of the option counts. This limited and calculable risk is, according to the experience of many traders, a great advantage of binary options.

The attractive yields of up to 91% (even more than 100% for special types of trade!) can be achieved within a very short time. Other types of trades are also available to trader, who can even achieve gains of up to 500 percent. Binary options are offered to traders with terms of days, weeks, months, and even a year. Especially the short maturities are preferred by experienced traders who want to earn their profits within a day. To get started, it is advisable to put more on the terms that are not less than a minute. In general, the short maturities of less than a minute are primarily popular with very risk-seeking traders. The broker IQ option even allows its traders 30-second trading. But it needs a good strategy to work.

The straightforward trading of binary options and the ability to generate high profits with only a small investment of capital represent two advantages. Furthermore, the risk of loss is limited to the chosen amount.

Various types of trading and additional functions
After the basic questions “What are binary options?” And “How do binary options work?” we try to talk about “Trading types and additional functions.” We will take a closer look at the many options available in binary options trading.

Traders trading binary options can earn substantial returns in both rising and falling price movements if the corresponding outcome occurs at the time of expiration. However, binary options trading only seems easy, trading strategies are needed to make personal trading more targeted and effective.

Trend-following strategy
The trend-following strategy assumes that the likelihood that a certain downward or upward trend will continue is greater than the likelihood that this trend will reverse. This leaves the trader with no more than watching the price of the underlying and opening a position when the price rises with a call option and when the price drops with a put option. True to the trading motto: “The trend is your friend!” Of course, the dealer should also be able to recognize when the trend will reverse.

Volatility strategy
Trends are not always easy to recognize and they do not always show themselves clearly. Strong price fluctuations sometimes make it difficult to identify a specific trend. This is where the volatility strategy with which a trader can benefit from these major price fluctuations picks up. Whether the courses develop in one direction or the other does not matter. With this strategy, it is important to keep an eye on business news. For example, you can expect high price fluctuations if important dates occur in a company, such as the publication of the quarterly figures. But other economic data, such as the interest rate adjustments of the respective central banks, let the prices rise or fall sharply.

Hedging strategy
The hedging strategy uses binary options to hedge against forex positions. However, with binary options not only currency positions can be hedged on a forex broker in the short term, but also equity positions (e.g. Microsoft and Intel shares.) The technical term for this is hedging. If you want to know more about hedging, you can read our guide.

In order to trade successfully in binary options, it is important to always be strategic. While binary options trading is not complicated, effective trading strategies can help systematically build a solid foundation for binary options trading. Because without a strategy underlying the trade successful trading is usually not crowned with success.

What to pay attention to when trading binary options
Binary options trading carries a number of risks, starting as early as the broker’s choice and ending in the decisions on stakes, assets, and maturities. The most important points for trading in binary options are summarized below:

As with other trading products, it is important in binary options trading to find a good broker before starting trading. Responsible brokers and related trading portals like to share their knowledge with their potential investors.
In addition, traders should keep reminding themselves that binary options trading is a risky financial deal. Although, the loss is limited to what to put on stake, there is still a risk of total loss as inexperienced traders often start betting more and more money in order to cover previous losses. Opportunities and risks must always be weighed rationally.

Trading in binary options is always based on a strategy. Emotions are bad advisors. A demo account can help develop and test your strategies.
If you have never traded binary options, you should try the respective trading platform and trading options with a free demo account without risk.
When selecting a Binary Options Broker, ensure that it is transparent about its regulation, deposit security, minimum deposit, order fees, spreads, and so on.
The offer of a free demo account is also an indication of a reputable broker is, but not a must.

Brokers offering loss coverage are preferable to other brokers. Newcomers should never invest more than two to five percent of their trading capital per trade. Risk management tools, such as stops, are to be used to limit losses. Market analysis tools offered by a broker should also be used.

In order to trade binary options, it is highly recommended for beginners to pay attention to some basic things before making their first trade. Above all, they should be sufficiently informed and use only a small fraction of their existing capital. Opportunities and risks are always rational. In addition, an action should always be based on a strategy.

Binary Options trading offers newcomers to trade in the best/easiest possible way. This is supported by the simple way of choosing up or down direction, as binary options are only about the rise or fall in prices. Nevertheless, it must be remembered that there is always a risk of loss. An optimal way to get started is to gain an overview with a demo account.

The broker’s choice also plays a major role in binary options trading. Basically, it is best to look at several factors, such as minimum trading, regulation, brokerage, and return. In our broker testing, we compared and verified different providers with regard to the individual aspects.
Binary options are a good choice, especially for beginners and advanced users, due to the clear risks, the simple way of trading, and the large selection of assets.

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