“To be successful, you must keep in mind that the only way you can continue to operate is to protect your account from a major setback or, worse, devastation. Avoiding large losses is the single most important factor for winning big as a speculator. You cannot control how much a stock rises, but in most cases, whether you take a small loss or a big loss is entirely your choice. There is one thing we can guarantee: if you cannot learn to accept small losses, sooner or later you will take big losses. It is inevitable.” – Mark Minervini (Source: Tradersonline-mag.com)
This is just to debunk myths surrounding binary options (also called fixed odds), opening our eyes to facts.
Arguments in Favor of Binary Options
Because of its plausible simplicity, many people are attracted to binary options, thinking that Forex requires a bit of getting used to. In fact, many so-called binary options experts have documented some logical arguments in favor of binary options, and to some extent they’re partially correct.
Did you think binary options (BO) have some advantages over Forex? OK, let’s examine a few advantages the experts claim BO has and see whether the advantages aren’t in Forex.
Myth 1
BO is based on time and FX is based on price. Most FX traders overlook time factor in their trading while BO traders are time-conscious.
Reality
The market doesn’t care whether you trade it based on price or time. You may enter with a specific timeframe or a specific price in mind, but that doesn’t guarantee anything. It’ll do what it’ll do without having you in mind, and this can be in your favor or against you, whether you trade BO or FX. You timing may be wrong immediately or later or never. You timing may be correct immediately or later or never. This has little role to play in your success.
Myth 2
BO traders are forced to exit a position in a given timeframe either with win or loss. Since they’re forced to do this, they’ve an advantage over FX traders who can refuse to exit a position with win or loss because of greed and fear.
Reality
Yes novice FX traders can hold onto losing positions and abort winners, which is a bad trading approach. But disciplined traders cut their losses and give their winners some leeway. Being forced to exit at a given time doesn’t make you the richest trader; otherwise, automated systems would be second to none. Being forced to exit always at predetermined levels can’t help if your trading approach is bad and the market has an inherent negative expectancy. The discipline you enforce on yourself is much more satisfying than the discipline someone imposes on you.
BO traders suffer the disadvantage of being forced out against their will, though the most important issue is profitability, which still eludes many in spite of being forced out at expiry periods. In FX, we’re comfortable exiting at our convenient time. We may continue running a profit in order to maximize it. From March 3 – 11, 2015, I’d have gained about 500 pips in case I went long on USDCHF and I let my profit run.
BO helps reduce emotions because risk and reward plus expiry are all fixed and predetermined.
Reality
All traders in all financial markets aren’t immune to emotions, so BO is no exception. Permanent success in trading includes a measure of managerial control of our positions. This isn’t possible in BO, for you remain helpless once a position is open, waiting for expiry.
Considering the myths and realities above, I’d like to chip in some fallacies some BO traders carry in their heads and the facts about the fallacies.
Higher Accuracy Fallacy
According to one source, BO by its nature requires a greater than win rate as each bet is factored 70% – 90% gain against 100% loss. So this means that you need to achieve as a BO trader a win rate above 50% on average 54% – 58% to just break even.
The fact is that in the long run no one can achieve more than 50% accuracy. 80%, 90%, 75% etc. hit rates are false in the end. They might be true in the hindsight, but not in live markets. Even scalpers who risk 500 USD to gain 2 USD per trade in FX trading would seem to have high hit rates, but this would drop significantly when the hit rates are reduced.
It is fallacious to think there are computer, automated, custom, alien, astronomical, spiritual, mental, discretionary, fundamental, manual, etc. strategies that enable us to get a hit rate which is higher than 50% in future. Marketers and novice traders would tell us so, but many people have lost money with systems that are promised to carry very high accuracy because the next moment (the future) can’t be predicted. Something that sounds great in theory can fail in practice and what looks like a perfect plan can be overturned by a factor beyond our control.
BO traders are often fooled into believing they can achieve a hit rate of 70% or more permanently. You might as well do that with a toss of a coin endlessly. No matter how good or how complicated your strategy or indicator is, you’re guaranteed only 50% hit rate or less in the long run. When tossing a coin endlessly, the share between heads and tails will balance off at 50/50.
Albeit, there can be times when heads will be hit more than tails within several weeks or months (or even years). You get heads 10 times, and tails 2 times. Then heads another 8 times and tails 3 times. Then heads 9 times and tails 4 times. This would give you a false impression that you’ve a trading approach with a high accuracy, without you being aware that it’s winning streaks that cause that. On a long-term basis, things would turn the other way and you get leveled at 50% because tails would begin to be hit more than heads (like getting tails 9 times and heads 2 times).
The only way to survive is to make more money in winning periods than you lose in losing periods. Does BO allow this?
Money Management Fallacy
Money management is very important in trading any financial markets, and so BO traders claim they can get ahead with good money management methods. The issue is this: can a good money management method help you in a game in which your risks will always be higher than your rewards? How can you survive in a game in which you’ll be paid only 70 or 80 USD for each 100 USD your risk?
If you win you gain 80 USD, but if you lose, you forfeit 100 USD. Does that appeal to you? What money management can you use?
It doesn’t matter whether you risk 1% or 0.5% or 2% per trade – you simply gain less than you stake no matter what you do. Money management makes sense only when your losses are smaller than your gains, not the other way round.
Let’s say you get paid 90 USD for each 100 USD (because this is the highest the most generous broker can give you) and you place 100 trades in a year.
Let’s use 100 trials with 90% payout ratio (most brokers pay only 50% – 80% of the capital risked). Let’s say you’ve a capital of about 10,000; assuming the money management is 1% per trade. 100 x 100 = 10,000.
You win 50%
90 USD X 50 = 4,500 USD
You lose 50%
-100 USD X 50 = -5,000 USD
Is this ever logical or rational?
In FX, we can risk 50 USD per trade to gain 200 USD. With this, we can lose 75% of our trades and still make money.
-50 USD X 75 = -3,750 USD (loss)
200 USD X 25 = 5,000 USD (win)
Doesn’t this make sense to you?
The only way to enjoy longer term success in BO is to use Martingale position sizing methods, which make you double your next stake to cover the previous loss (and this doesn’t present any huge edge in itself). Please search for information on the Internet in order to know what Martingale is and how it works.
Martingale isn’t ideal for most traders because they don’t have enough money. This is a serious problem. Too many traders open accounts with too small funds, and under such circumstances, good money management can’t be practiced.
Unfortunately, those who’ve big accounts either don’t understand concepts of excellent position sizing or fail to respect the concepts.
This leads us to the Gambler’s fallacy. When you’re in a losing streak, you think your chances of winning improve with next positions, since your previous ones are losses. You think the winners are around the corner. Doubling your stakes with each loss increases your negativity and depletes your account quickly.
Maybe after 4 losing trades, which cost you 2,000 USD, you double your stake to 4,000 USD. You could have the 5th straight loss because you’re still in a losing streak.
Even if you wait for 4 losses in a row before risking 20% of your account to recover the recent losses, you still face a gambler’s problem because your next trade could be a loss, and this has nothing to do with what happened to you in the past.
The Grass Is Always Greener on the Other Side of the Fence
Some hate transport business and some love it. The risks in transport business (accidents, failures, low patronage, losses, problems with authorities, etc.) don’t deter some people from doing it because of its rewards. Some who fail at agriculture think sports is better. Some who fail at politics now want to try publishing, whereas publishing has its own challenges. Some who’ve been disillusioned with salaried jobs now want to try music industry; whereas it isn’t easy to be a celebrity or a promoter. Some who started their business has also seen that remaining profitable isn’t easy. Certain people don’t want to do anything with trading until they’re financially down, having exhausted all other alternatives. Is that the right time to become a trader?
Those who don’t make money with CFD believe spread betting is better. Those who hate shares markets consider futures markets. Those who have problems with FX think BO is better.
What do you want to do with your life? What do you want to do for a living? What can you do to put food on your table (or to feed your kids, if you’re a parent)? Life’s short: only 70 – 90 years, and some don’t even reach that age bracket. A short life is meaningful if one’s financially free and is fulfilled.
I didn’t mean to anger BO traders. BO is good and it offers nice potentials, but people are also blinded to its pitfalls and inherent disadvantages. A business that always makes profits that are bigger than expenses will sometimes go thru turbulent times, how much more a business that makes profits that are always smaller than expenses!
If I made a business proposal to you, telling you that your income/profits from the business would be primarily, permanently less than your expenses and other costs of running the business, would you agree to the business proposal? Does that kind of business sound rational to you? Sadly, this is the permanent reality of BO.
It doesn’t make sense to run a business in which the costs will always be bigger than income. I’ll trade BO only when brokers start giving us the possibility of getting reward that is bigger than risk per trade. However, I sense that this may put them at a demerit.
Conclusion: The most exciting thing about market is its unpredictability. The unpredictability of our trading career isn’t always thrilling, however. We devise and strategize. We make trading plans, projections and proposals about what we’d like to see happen to our portfolios, but often they’re little more than our best guesses. We’ve no idea what a day, a week, a month or even a year might bring.
“Why don’t you just play around with the idea that you can be wrong and still be successful. Being right or wrong is a meaningless invention of your mind. Instead, what if you just developed a good system and practiced following it? A loss has nothing to do with being wrong. Instead, a loss has everything to do with following your system and not making a mistake…. So what if you just accepted losses when you got them, allowing them to be small losses and let your profits run when you have a good trade? Don’t you think that might be a good idea?” – Dr. Van K. Tharp (Source: Vantharp.com)
This piece was first posted on ADVFN
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