HOW DO BINARY OPTIONS WORK?
The binary options market is a financial market where a trader wins a payout by being able to predict the direction or the behavior of the traded asset, and being able to achieve this within the allotted validity period of the trade. From this definition, there are several points to note about how binary options work:
a) The trade success is partly based on outcome of the prediction of the direction or behavior. This means that success in a binary options trade depends on the price of the asset heading in one direction or the other (up or down, higher or lower) and the trader getting it right. It also means that success in the trade can depend on the asset exhibiting a particular behavior such as staying within a range of consolidation or experiencing a price breakout (the In/Out or boundary option) or displaying certain movements such as getting to a particular price level or not being able to breach a particular price level (the Touch/No Touch option).
b) All trades in the binary options market have a validity period; they are not meant to remain open forever. The validity period is determined by the expiry date or time. Sometimes the trader has the liberty of setting the expiry, and at other times, the expiry is set on the broker’s platform by default.
c) The next point is the profit percentage. Whenever a trader chooses a payout, the payout is made up of the initial capital in the trade and the profit. The lesser the amount invested, the more the profit. These two parameters determine the risk-reward ratio. The best scenario is to be able to pick trades in which the capital invested into the trade is almost equivalent to the profit. This puts the risk-reward ratio almost at par. Due to the fact that the broker’s commission is added to the cost of the trade, the amount invested will always exceed the profit. The capital invested into the trade and the profit to be made can never be the same. Certain factors determine the balance between the two parameters. If the trade is one in which the outcome can almost certainly be predicted with a certainty approaching 100%, the trade will demand a lot more capital and very little profit. The less certain the trade outcome, the more profit can be made from the trade. In addition, if the expiry is set to the point where the trade is more likely than not to end in the trader’s favour, then the trade will be more costly to execute. Traders should therefore pick trade scenarios where the outcome is not too obvious and should also not set expiries that almost certainly will allow the trade to end in the money.
These three points are factors the trader should consider carefully, because they answer the question: how do binary options work? The nitty-gritty of how to achieve these three points are things the trader will eventually master with careful study and practice.