How Do Binary Option Brokers Make Money?
Binary Options are the newest way of trading short-term options on online platforms. Being quite straightforward and with little amount required to register, they are becoming very popular. The concept of Binary Options trading is based on determining whether the price of an underlying asset will be higher or lower in a specific period of time. Binary options traders are given the freedom to choose both the asset and the timeframe and this makes short-term options trading very attractive.
Binary option brokers, unlike forex or stock market brokers, don’t charge their clients any commission on orders. Obviously they are making money some way as they would not exist on the market otherwise. These are ways by which brokers make money:
- by cashing in money placed on losing trades;
- by the trading activities of their traders
- by working on an exchange model.
Binary Option brokers earn money by cashing in the money placed on losing trades. If you place a bid and you predicted it wrongly, you lose all your money invested in that trade. That money goes to your broker, who may, if they offer that option, give you some percentage back. This is quite rare but it exists and some brokers offer 10% back of your trade amount if you lose. These kind of offers are usually bound to specific trading hours and specific trading pairs.
Binary Option brokers gain money by the trading activities of their traders. That means that if you place a bid and you predicted it correctly, you will receive your money back plus extra 80% (not 100%). In an ideal world, let’s say that
100 people bid $10 that GBP/USD will go up within 1h and another 100 people bid $10 that this pair will go down. Broker gathers $2000 in total. After the bid is finished and GBP/USD went up and the people who lost, lost everything, and the people who won, won 80%. As such, the broker has to pay out $1800 to the winners and is richer $200.
This is an ideal example to show how brokers make money by pocketing the difference between the percentage that losers will lose and the percentage that winners will make.
Very important note on scam brokers
When you buy binary options you essentially make a bet against the house, your binary broker. You do not invest in the asset directly. It is just like in betting when you play against the house. Binary options is similar but you don’t bet on a horse or a team but a financial asset, commodity, or stock.
In theory, binary brokers’ model should be based on a 50/50 chance. It is unfortunate that some rogue brokers sometimes tweak this model in their favour and scam users.
These scam brokers have one single aim, to scam as many people as they can before they close down. Their model is to attract inexperienced traders who will approach binary options and play on luck. If someone learns to trade and gets better and starts winning, a scam broker will withhold withdrawals until that money is reinvested back into the broker’s platform.
Scam brokers are usually quickly exposed but unfortunately people still fall victims to clever and enticing marketing campaigns. The best way to choose a broker is to see whether a broker is regulated and has been operating for at least a year. Checking user reviews online is also recommended before signing up and making a deposit with any broker. We have compiled a list of trusted brokers which can be used as a comparison chart. Follow this link to compare brokers and read our FREE introductory guide on How to choose a binary option broker.
Other ways binary option brokers earn money
Additional way for binary option brokers to make money is by working on an exchange model which allows traders to bet against each other. So, money lost by one trader goes to another trader. It may sound like the money will never go to the broker, but in this case scenario the broker charges a commission on the contract purchased by the traders. The amount of commission depends on the amount invested in the trades.
Looking closer at the last two scenarios we can see that the way broker makes money doesn’t actually make any difference to either losing or winning trader. Losing trader will lose all invested money in particular trade and winning trader will win % of the money (either due to payout rate or commission).
Of course making making money on trades is often not enough. Most binary brokers will also charge, so called, miscellaneous fees. Those additional fees often include:
- micro charges for each money transfer,
- a small percentage from withdrawals, and/or
- for the actual account management.
Check your broker’s terms and conditions
Having read the above, now you know how important it is to check your broker’s terms and conditions in order to choose the best broker for yourself. We strongly advise using a broker that will let you open a demo account and test its trading platform for responsiveness, accessibility and the ease of use.
Not all binary brokers offer a demo account. With many brokers you have to make a deposit first and open a real trading account, only then you can be offered a demo account with about $5,000-$10,000. Demo accounts are also referred to as Practice accounts.Published in Education