If we ignore costs, the trading of Binary Options is basically a zero sum game. In other words, for every winner there is a loser of equivalent $ amount.
But, there are costs in the form of what the broker earns. Therefore, it must be the case that the average trader is not breaking even.
So, you must be achieving above average.
A trading edge is a skill or insight or process that means you are better than the traders with whom you interact when you trade. If you have something that gives you an edge then you have a chance of being profitable.
When trading Binary Options, the key driver of profits is the percentage of winners. Of course this must be allied with good risk control and the payout ratio will also be important but this is the most important metric.
If you trade with no edge then you should expect that 50% of your trades will win. After all, it’s basically a coin toss.
You might get lucky and have a large number of wins over a period. Every gambler has a winning streak. But luck is just statistical probability in action. Luck never lasts forever and then you lose big
The Importance of the Win Rate
If you are trading with an average payout in the region of 75% you will need close to a 60% win rate – just above 57% to be precise – to be profitable.
Since, it is reasonable to expect that random trading will produce 50% success, the question you must address is how you can get your success rate up from 50% to 60% or above
What success rate are you likely to achieve with the system you are using to identify trades?
Vendors of signaling software or robots often claim success rates of 80% or even more, the implication being that if you took the trade in line with the signal then you will have a winning trade 80% of the time.
This sounds good, but is it too good?
It certainly looks very good when you compare it with the results that are obtained by most financial traders in mainstream instruments.
In general, financial traders in traditional sectors aim for success rates in the range of 40%, although day traders will typically look for higher.
With good money management you will be very successful if you achieve this. This is done by only taking trades with a reasonable expectation that the potential gains are greater than the potential losses by a factor of at least 2.5 times.
What returns can you earn?
Let’s say you buy a signaling product that claims 80% success. These are typically priced at around $100.
To assess claims of 80% wins, let’s see what such a success rate would mean in terms of profits.
Assume you take 100 trades with $10 risk on each. Let’s say you have a success rate of 80% and an average payout ratio of 75%.
This would mean that this trading makes a profit of $400. To see this, you won 80 out of the 100 trades and you earned a profit of $7.50 on each. So total winnings amounted to $600. You lost $10 on each of the 20 losing trades so your profit is $400. Your software has already paid for itself.
Now let’s say you were trading quite conservatively so that you allowed 2% risk per trade and you took 5 trades per trading day. It would take about a month to reach 100 trades.
For $10 risk per trade then the fund must have been $500 to start. You would have made a profit of 80% in a month.
How does that sound to you?
Pretty good. So you keep it going simply following the signals that are provided by the software you have purchased.
The next month your fund is now $900 so you can increase your trade size to $18 and still keep within the 2% per trade limit.
If you keep this up and constantly add your winnings to your find and increase your trade size accordingly, in a little over a year your fund will have grown from $500 to around $1 million.
So, in a year, you’re a millionaire. Without really doing very much in terms of learning or market analysis. After all, signals are pretty easy to follow and it’s very easy to place trades. Your only input is really just a few minutes a day.
But what is your trading edge? Why should you expect to earn money so easily. After all, someone else must be losing that money.
Does this seem reasonable to you?
If it’s that simple, why isn’t everyone doing it? Any why are all the traders in traditional markets not using these simple programs instead of aiming for returns in the region of 10 to 15% per annum?
Clearly there’s something wrong here. What’s wrong is that you cannot expect that any system will give you consistent returns of 80% winners over anything other than very short periods.
So, are the providers of these software products lying about their results? While some may well be lying, many probably are not. Their tests may well have shown that their system would have produced 80% success over a given period.
What is going on here?
The problem is that the likely test is almost certainly that they have run a program on a past data set and identified a set of parametres for various statistical indicators that best predicted what happened next in that dataset.
It is conceivably possible that this could be correct 80% of the time. Indeed, an alert trader could have had 100% success using a past dataset. However, it’s a whole different matter to try to predict what will happen next into the future.
So, forget about achieving 80% success, or even 70%. For a start, aim for 60%. This would mean you will be profitable, even if the payout ratio is a bit low.
If you can’t achieve 60% wins, why would you expect 70% or 80%?
What is the role of automation?
You will soon find it is difficult and you will need all the assistance you can get. So, do automated programs work?
Some systems will be total failures while some may have a role to play within a trading system as an aid or an alert system. But that, in my opinion, is all.
I am not saying you should not have a look at some automation. But only as part of a system.
If you are considering buying such a program and there are claims in relation to its success, ask if the claims are based on back testing or are based on live trading.
It’s unlikely you will get a clear, convincing answer and so you can draw your own conclusions.