Binary options trading is different from spot Forex trading or simply put, spot trading. However, both of them require speculation and analysis. The traders need to speculate the market position at a certain point in time and this speculation can be done somewhat accurately only if the traders know how to analyze the market. Their profit and loss will depend on their analytical capabilities and the speculation power.
Profit and Loss Calculations: Spot Trading
In case of spot trading, profits or losses are calculated by taking the number of pips a person or a trader moves up or down and multiplying them with the value of each pip based on the size of the trader’s position. In this form of trading, the profits and losses constantly change until market movement stops with the expiry of the trade.
Example: Let us assume that the trader is trading in the currency pair EUR/USD at the price of 1.2500. During the trading period, the price can move up to 1.2600. So, the increase in the number of pips is 1.2600 – 1.2500 = 100. Assuming that the value per pip is $10, the trader will then have a profit of $10 x 100 = $1,000. If however, the price of EUR/USD falls to 1.2400, the number of pips lost by the trader will be 100 and hence, the loss will be $1,000. The third possible case is that at the end of the trading period, the price of EUR/USD stays at $1.2500. Thus, the trader will not earn any pips and hence, no profit or no loss occurs.
Profit and Loss Calculations: Binary Options Trading
In binary options trading, the profit you can earn or the money you will lose will be predefined as per the contract. So, irrespective of the price fluctuations or market movements, your profit/loss ratio will stay constant.
Example: Let us assume that a trader enters the market and trades in EUR/USD with the price being 1.2500. He predicts that the price will go up and buys a Call option of $100. The moment he buys the option, he agrees on a contract that if his predict becomes right, the broker will pay him $190 at the end of trading period if the price of EUR/USD moves above 1.2500 or stays at 1.2500. If the trader’s assumption turns out to be right, the broker will pay him $190 and so, the net profit earned by the trader will be $190-$100 = $90. The contract will also state that of the trader loses the trade, i.e. if his assumption turns out to be incorrect, the broker will forfeit the premium paid or the money invested by the trader and will give nothing. So, if the trader loses, the broker pays nothing and the trader loses $90 in case the price of EUR/USD fails to move above 1.2500 or falls below that level. There are no neutral or break even outcomes.
So, the basic different between binary options trading and spot trading is the potential outcome. In case of strong trends, spot trading can lead to massive profits or the other way round, lead to massive loses that can exceed the amount invested by the trader. Taking the example giving for spot trading, if the price of EUR/USD falls to 1.1000 from 1.2500 during the trading period, the number of pips lost by the trader will be 1.2500 -1.1000 = 1,000. So, the trader will be losing $10 x 1,000 = $10,000. This is a massive loss considering the fact that the trader bought just one lot EUR/USD for $10 and ended up losing $10,000.
Spot trading is always dependent on time. The greater the expiry time, the better it is because the chance of market recovery after a bad patch are high. In binary options trading, time is not a big weapon in hand for some forms of trading like Touch and No Touch options. If the trader’s assumptions turn out to be correct or incorrect at any point during the trading time, the trade will close without waiting for the trade to complete whole time frame and the trader will make money or lose money. The possibility of losing more than invest is not present in binary options trading. At the most, the trader will lose only the amount invested and the trader will know this even before the trade starts. It is because of this, binary options trading is called trading with calculated risks.