A scam is a dishonest representation, meant to trick someone. What makes binary options a scam is that it presents itself as an investment method, while it is nothing short of gambling with bad odds.
The simplicity of binary options is part of its attraction.
Binary means “two” and refers to the fact that you only have to make a single decision about one of two outcomes. You decide on whether you think a certain asset will rise or fall in the future.
The size of the movement does not matter. If you are wrong, you lose the money you have “invested”.
If you are right, you will get a pay out of between 65%-85% of the “invested amount”. Note this is already unfair as you stand to lose 100%, but you can never win 100%.
Some brokers will give you a small percentage – 5% to 15% – back, in case you lose, but they compensate this by giving you less when you win.
You can bet on almost any asset: stocks (for example Shell), indexes (for example the Dow Jones), commodities (for example gold, oil), or currency pairs (for example Ringgit and Dollar).
Here is the tricky part: the duration of the binary option is extremely short. It typically ranges from 60 seconds to 24 hours.
For such short time periods, assets move in essentially random directions and cannot be predicted. The short duration makes any investment technique worthless.
Binary option brokers will tell you “the trend is your friend”, but to call movements of a few second or minutes ‘trends’ is a grave misuse of the term. If you do spot a trend, it is only because the human mind is trained to see patterns and trends, even if they aren’t really there.
Similar to how people see “trends” at the roulette table, while it is completely random what happens: roulette balls have no memory and don’t care what happened the previous roll.
This means you are not investing, but gambling. It is just that you have worse payout ratios than if you were to go to the casino and gamble red or black on the roulette table.
Predicting what the stock is going to do in the next ten minutes is impossible, even for companies about which an abundance of information is available, such as Apple or Facebook.
Random, unrelated events, such as interest announcements, large buyers / sellers, bad weather, a terrorist attack or a flash-crash could temporarily influence the stock price.
But more often, there is no attributable reason at all for short term stock movements. This makes binary options gambling with unfair chances. The broker will always win at the end, just like at the casino.
As short-term fluctuations in stock prices are random and irrational, you have 50% chance of being right. Let’s say you “invest” RM100 and are wrong, you lose RM100. If you “invest” RM 100 and are right, you will get RM75 (a payout percentage of 75% is common).
This means on average you will lose RM12.5 per trade: (lose RM100 + win RM75) / 2 trades. Betting red or black on the roulette table is a better deal (through you will still lose on average), as the payout is 100% and the chance that you win is 18/38= 47% (due to the occurrence of the 0 and 00).
As you have to accept the 75% payout, it means you would need to be right in 57% of your gambles, instead of 50%, in order to break even. In order to win money, you need to be right even more often! This is because 57% x RM 75 (you win) – 43% x RM 100 (you lose) equals zero Ringgit.
But there is no knowledge that can help you to improve your win rate to 57%. After multiple gambles, you will always gravitate toward the 50% average and lose money.
It is easy to see how all the human weaknesses – greed, jealousy, overconfidence in your own trading ability and knowledge plus the underestimation of risk – come into play when you see the unwanted ads for binary options pop up on your screen.
They scream at you: “no knowledge required!”, “Make money from your own home”, “Start earning thousands of ringgits in a few hours”. Then, the fake testimonies from paid actors start to play. It’s the latest ‘get rich quick’ scheme. It’s too good to be true, literally.
You don’t need to be Einstein to realise this is a scam. If it would work as advertised, everybody would do it. Regrettably, it is always the financially illiterate people that end up being the victim and become even poorer as a result, while the brokers are the only ones who profit.
No serious investor, such as Warren Buffet, would ever consider binary options. No financial investor worth his or her salt would advise it.
Short term stock movements are “noise” that can only be filtered out by holding a stock for an extended period of time – not even months, but years.
As Warren Buffet said in his Chairman letter of 1988: “Our favorite holding period is forever.”
Mark Reijman is co-founder and managing director of http://www.comparehero.my/, dedicated to increasing financial literacy and to help you save time and money by comparing all credit cards, loans and broadband plans in Malaysia.
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