Why Traders Prefer CFDs over Binary Options
More and more traders are quitting binary options, in favor of CFD trading. Even though binary options do work for some traders, they can only meet 10% of their trading requirements. In my opinion, the whole binary options concept failed to catch up, because it focused too much on high frequency trading. Also, Binary option brokers focused too much on incentives, such as welcome bonuses and rebates on losing trades, but they missed real traders’ needs. So to this day, it’s only few binary option brokers who offer One Touch type options and other useful tools. These do work, but only a handful of traders can use them profitably.
In terms of regulation, there were brokers that had been poorly or not regulated at all. But I do believe this has little to do with the broader decline of this industry. Even with regulated binary option brokers, the trading tools were limited to fast day trading. And moreover, the payouts were poor. In relation to CFDs, binary options offer a much lower probability of trading success. Because it’s much harder to predict both price and time exactly right. So, from a probability perspective alone, most traders were doomed to fail from the start. Some good traders made very good money. However I do suspect they did so through One Touch type binary options, and not on 30 minute or 5 minute options.
So I do understand that more and more people treated binary options as a form of gambling or fun game. A game having poor odds of success, and not being a serious trading tool. CFDs on the other hand were developed as early as 1990, and were adapted by professional bankers engaging in responsible financial trading. It was a trading tool they trusted their own jobs with. And they saw good potential, and no greater risk than in any other leveraged financial product available.
The Binary Options Limited Risk Myth
Binary options were promoted as fixed-risk financial bets, so they were supposed to be lower risk than CFDs. Since all you stand to lose is the original trade money, and you never get a margin call when the trade goes bad. In theory this is true, binary options do offer limited risk compared to CFDs. But in practical terms, when one takes into account probability, it’s another story. The shorter the time frame of choice, the more likely it is that you will lose. So it’s not so much the concept of binary options that is wrong, but rather it’s the poor payouts and the focus on very short term trading.
CFDs have a theoretically unlimited risk when a trade goes wrong and no stop loss order is in place. But in practical terms, CFD investors and traders know how to handle this risk. Stock investors for example, who already hold stocks, are totally hedged against their CFD trades. No matter how risky they seem. If the CFD trade loses money, they make the exact amount of money on the long stock. But when the stock loses money, it’s only a paper loss, the trade is not closed. The hedging CFD trade is closed soon, and it makes real money. This is the first original use of CFDs in the investment world. And this long stock – short CFD asymmetry directly offers a huge asymmetrical advantage. So you can risk too little, to make a lot. This you cannot do with binary options because it’s very hard to predict stock prices in both price and time.
I have also confirmed this while talking to real, deep pocket traders, those who make big money consistently. And they all use CFDs in one way or another. Very few use One Touch binary options, and nobody uses binary options on the 30 minute time frame. People who start in binary options, with $2,000 or less, think that this is a great way to make a lot of money, since they cannot commit the large money that big traders commit. And they simply think that by trading at very high frequency, they will be able to match the performance of those big CFD traders and investors. But it’s all an illusion. Large profits require large trading capital.
In my opinion, as I have seen in actual trading tests. The only way to make money in binary options is by trading solid multi-week trends, in markets as such as gold or crude oil. And only through One Touch Binary options, offering payouts of 300% to 600%. This is possible, but it’s only the exception to the rule. Try trading various forex trends, and you will find no solid trend. Try trading gold or crude oil using 30 minute binary options, and you will see that it’s very hard to win consistently.
CFD Trading is Gaining Ground
Even though some countries still ban CFDs and binary options, such as the United States. If you look around the world, many countries allow CFDs trading, but don’t allow binary options. Or very often they give licenses to very few binary option brokers. By their nature CFDs are more solid and more professional financial instruments. And many established forex brokers actually offer both spot and CFD markets, such as gold, all in one account. Whereas binary options are considered more like a toy for people willing to play with the markets. Of course there are binary brokers who can facilitate very large trading, so you shouldn’t think of all binary brokers the same way, because there are some important differences.
CFD trading is all about serious trading, and even profits arising from CFD dealing are taxed as serious investment income, in many countries. That’s why CFD trading is gaining so much popularity among investors and traders while binary options are pushed aside. You may be wondering what is CFD trading and why it’s so popular, but it has little to do with advertising and promotional offers. People prefer CFD trading because of its inner, hidden benefits. Whereas binary options have been pushed by advertising alone, and they offer very few benefits and only in rare cases.
Why the Law in Some Countries Prohibits Binary Option Trading
The law in many countries prohibits binary options because the brokers offering these instruments are not properly run. And there are conflicts of interests. And that’s because most binary option brokers are not sophisticated enough to hedge market risk. CFD brokers are banned in some countries too, but that’s because the regulatory authorities in these countries prohibit high leverage trading, of all kinds. Even forex trading is limited to small leverage, in USA it’s limited to just 50:1.
The conflicts of interests problem means that regulators require brokers to hedge risk properly, through the real markets. And not to bet against their clients. CFD brokers hedge risk, and especially DMA CFD brokers even more so. Binary brokers however have to have very sophisticated software and large liquidity pools to do this. And many binary brokers simply fail to meet these standards, at least to this day.
Innovative Binary Brokers Welcome the CFD Revolution
More and more binary brokers are looking to either switch to CFD-only trading, or add CFD products to their offered services. Some brokers such as 24Option.com are offering both binary and CFD, and also a new version of binary options, known as digital options. This is all in an effort to deliver the natural next step in binary trading. Which other brokers had failed to deliver.
Other innovative brokers are IQoption.com, Bulltraders.com, Binoption.net and more. It appears that more and more of the professional binary brokers will inevitably offer some kind of CFD trading, and they will also innovate upon their binary products. Because that’s what traders demand.
As far as the binary brokers themselves are concerned, I do believe that some of them will evolve well, and will implement more advanced trading through more modern software. This is the only way to really avoid conflicts of interests and to properly hedge their own net exposure to the markets. Deep down, what really matters is the way that a broker handles clients’ trades, and the level of liquidity they can provide. The missing part now is the advanced software, to convert binary risk into linear risk and to convey the risk onto the real markets, like CFDs do. For example when I buy a Call binary option and I pay a $100 premium, it needs to be converted into an equivalent CFD or spot market trade.
Up to this day however the software is still primitive, binary options are only suitable for small size trading, and cannot match the efficiency of CFD trading. Binary brokers’ software has trouble adding up clients’ trades and converting them accurately into CFD or spot trades. That’s why they cannot offer us wide range of expiry times and unlimited features.
Serious traders who use binary options today, are looking to trade very selectively. And only trade One Touch options, or other types that offer as high payouts. In doing so, they effectively risk little money relative to how much they stand to win. 5 minute and 30 minute binary options are not in any case useful to serious traders, and they are usually avoided.
From my experience with veteran profitable traders, I have found that they tend to specialize a lot in their markets of choice, and they generally avoid not just fast binary options, but also any kind of fast trading, except scalping. The brokerage industry tends to promote high frequency trading but wise traders tend to stay away from it. Because they make their money in slow, thoughtful trading strategies.
On the other hand, binary brokers who failed to embrace CFD trading and innovative binary solutions, are likely to lose many more clients and eventually go out of business. It is now very clear that binary options are not really better overall just because they offer fixed risk. So I do expect to see big changes in the marketplace in the coming years where only the best binary brokers will survive. And these will be binary brokers with proprietary software and trading platforms, not generic software.
What is the Real Potential of CFD Trading?
CFD trading seems to offer unlimited trading risk, because a market can keep on moving against your open trade. That’s true of all markets and all classic trading instruments too. But these markets work linearly. Especially CFDs work even more linearly and you start making a profit from the first cent of favorable market movement. In binary trading sometimes you have the choice to close a profitable trade earlier. But the profit is minimal! This is the big trap of binary options, especially short term ones. Because compared to CFDs, they offer limited payout. So in reality, binary options, in the vast majority of trades actually are more risky than CFDs. Yes money at risk is fixed but the potential reward compared to the premium you pay, is too small. It’s just out of proportion as veteran traders say.
To really make fair comparisons between CFDs, binary options and other financial instruments, you have to use simple statistics. And you also need to consider trades where your prediction is only about 50% to 60% right. Only then you can see which is best for you, and you soon find out that CFDs are the best.
You can see in actual trading, that most of the time, even when you are right, you are not perfectly right. For example you expect EURUSD to rise by 100 pips, and it ends up rising only by 50 pips. And that’s how you should calculate all your trades. Because that’s how real markets work. You can think of binary options as trading probability, whereas with CFDs you are trading market price, penny for penny. Market price is linear, whereas probability is exponential and tricky.
Finally, there are those who say that you can use CFDs and binaries, all in one strategy, so as to use binaries to hedge the risk of CFDs, and this is true. But it does work in very special cases. In all cases you can trade CFDs in one direction and still hedge most of the risk in the opposite direction with another CFD trade, on another related market. And once again you will find that the payouts of the pure CFD strategies are better than those of CFD-binary strategies. So it stands to reason which one is really better. Especially in forex trading where CFDs will pay you daily interest on positive interest rate differentials. Whereas when forex trading through binary options you have time working against you. And that’s one more factor to take into account, in every forex trade.