If you are a new trader who is looking for ideal investment methods with a good risk-to-reward ratio, you might be wondering whether to choose binary options or forex trading. While binary options are relatively new investment techniques, spot forex trading has existed in the market for ages. Both these trading forms are accessible easily through online or mobile trading platforms. While Forex market is open on 24/7 basis, binary options can be traded only for limited hours when the underlying asset market is open. They both require very less capital compared to other trading methods like stocks or commodities. For instance, you can start investing in binary options or forex trading with a minimum investment of 250$, and this can vary depending on the broker you choose.
In binary options, you won’t be charged any commission for the trades you execute whereas forex brokers may charge you commissions for each trade based on the percentage of spread. You should consider this factor while calculating your profit percentage in forex trading.
While forex trading is based purely on the price movement of currency pairs, binary options involve speculating the price movement of various underlying assets like stocks, market Indices, commodities and currency pairs. You can choose short or long term positions in both these trading methods based on your investment strategy. Since binary options are derivatives in which you trade on the price movement of underlying assets, it does not give you ownership of any of these assets. Unlike binary options, investors buy and own the real currency in spot forex trading which they try to sell later for a better exchange rate. You can go through reviews of various brokers like anyoption review to decide which one offers the maximum payout percentage.
While the risk-to-reward ratio is fixed in binary options and based on the payout percentage offered by brokers, it varies a lot in Forex trading based on the amount of leveraging and stop-loss limits chosen by the investor. For example, if you invest $100 in a binary option trade where you speculate spot gold price will increase by $10 at the end of expiry time, and your broker offers a payout of 80%, then you will get a profit of $80 if your speculation is correct or lose your investment of $100 if your option expires out of the money. In this example, the risk-to-reward ratio for that particular trade is 1/0.8 which will be constant for any trade performed with that broker.
Hence binary options are much simpler than forex trading since you know both the potential risk and profit in advance. Some brokers may offer a rebate of up to 15% based on the profit percentage you choose. Since the returns are fixed in binary options, you can make profits only if you maintain a very good success rate. If your success rate is just 50%, then your overall loss will be more than what you would have gained from successful trades. Only if you maintain a win-loss ratio of at least 70%, you can be profitable in binary options.
But in forex trading, you can make use of leveraging to increase your profit percentage and use stop-loss orders to control your risk. Many Forex brokers support leveraging up to a maximum of 100:1 which means you can invest up to $100, 000 on a single trade by having a balance of only $1,000 in your trading account. With leveraging ratio of 100:1, you only commit $1,000 to your trade but you have the potential to earn profits on the equivalent of a $100,000 trade. You can make huge profits with the help of leveraging in forex trading but at the same time it is also very risky and can lead to bankruptcy. If you don’t use the stop-loss technique in forex trading, then your risk is unknown which can be dangerous. You can also set profit targets in your trade to take profits at a certain price level. In forex trading, your profit can vary based on the magnitude of price movement in the currency pair whereas in binary options your profit is always constant irrespective of the magnitude of the price movement of your underlying asset.
Let’s consider a spot forex trading example. Let’s say you are investing in EUR/USD currency pair in spread betting and you opt for $20 per pip. You also choose a stop loss order placed at 3 pips and stop limit of 9 pips. In this case, your risk to profit ratio is 1:2 which means you will earn double the amount of money when compared to what you may lose if your trade is unsuccessful. In the above example, if the market is moving in your favour and your position reaches 9 pips, then your trade will close automatically because of stop limit. You will get a profit $160 if your trade is successful ($180 [9 * $20 per pip] – $20 [for the spread]). In the same example, if the market is moving against your favour then you will only lose $80 because you have set stop loss order at 3 pips (3*$20 = $60 + $20 for the spread = 80$).
Forex trading provides the flexibility to limit your losses with the help of stop loss orders and also to boost your profits with the help of leveraging. This can be very helpful for experienced investors who have good knowledge in the currency market and use of leveraging and stop loss techniques to maximise their returns. But for beginners who lack awareness about such trading strategies and the currency market, forex trading might be risky. On the other hand, binary options are very simple and offer fixed returns with pre-determined risk which can be a good choice for novice investors.