What is the difference between forex trading (also called Foreign Exchange) and binary options on forex? You can find this question on countless internet forums at the moment. This question makes no sense. If you don’t understand why, you should not try to make money with binary options. These two investments are extremely different, they do not share the same purposes, they do not share the same economic reasons and they concern two different types of investors. We already compared binary options with common options; we will now try to present the key differences between forex trading and binary options on forex.
Differences between binary options on forex and regular forex
In order to help you understand the key differences between these two instruments, we will remind you the definition of these two investments:
- Forex is a market: it is the market of currency exchanges. A forex trader limits his exposure to the currency exchange market. A forex trader will never speculate on a company stock, a commodity or any other asset class. He will for instance invest in the Euro-Dollar. He will buy a certain amount of dollars with a certain amount of euro in the off chance that, in the future, he will be able to re-exchange this same amount of dollar for a bigger amount of euros. This is what happens when the EURUSD exchange rate is decreasing. A forex trader will say that the Dollar appreciates against the Euro. Moreover, the forex market is used by many different market participants. A company that sells its goods abroad in dollars but pays its employees in British pounds will need to use the forex market to convert these earned dollars for a in British pounds.
- A Binary option is an instrument: a financial instrument that enables retail traders to speculate on different markets (forex, equity stocks, indices, commodities…). It also enables them to leverage their investment in order to generate high profits in a short amount of time. Binary options are derivative products with a final payoff that is conditional to the level of the underlying asset at maturity of the option.
- FOREX – A forex trader is bullish on the US dollar against the Euro and spot rate is 1.3230. He will invest 1000 EUR and buy 1323 dollars. One month later, the EURUSD exchange is 1.3120, the trader will convert its 1323 USD and get back (1323 / 1.3120) 1008.38 EUR. In one month, the forex trader generates a profit of 8.38 euros. You need to invest large amounts of cash to make money with forex trading.
- BINARY OPTIONS – A binary option trader is also bullish on the US Dollar against the Euro and the current exchange rate is still 1.3230. He will invest 100 EUR on a LOW binary option on EURUSD with maturity 15 minutes and a RETURN of 75%. If after 15 minutes, the EURUSD exchange rate is below 1.3230, the trader generates a profit of 75 Euro while he only invested 100 euros. You don’t need to invest a large amount of cash to generate a large profit with binary options. Compared to forex, the binary option trader cannot lose more than its invested amount.
Differences and main advantages of binary options versus forex
- Larger portfolio of available underlying assets (stocks, indices, commodities and of course forex).
- Losses are limited to your invested amount and you already know your achievable return when you open the transaction.
- No collateral requirement by the broker. When you want to invest 100 GBP, you only need to have 100 GBP on your account while brokers are requesting bigger capital requirements for pure forex trading.
- Multiple instruments and strategies available (High / Low, One Touch, Zone…).
- Greater freedom and transparency: you can craft your own binary options with the « option builder » while pure forex investment are standardized.
- No commission on binary options while proportional commission on forex that can represent a significant share of your investment.
As explained above, the success of binary options is mainly due to the multiple advantages of this financial instrument compared to forex and other traditional financial tools. Binary options are simple instrument, you just need to choose a direction for a specific underlying and be right about it to make money.