How do binary brokers make money? It’s not usually what they claim.
A common question that many traders have is how these offshore binary options brokers actually make money. The basic answer is that these binary options companies operate on a business model very similar to that of a casino.
Many assume that these brokers can’t possibly operate this way due to all the strong traders out there putting big money into each trade and putting them out of business in the process.
But the actual truth is only a very select number of traders are actually profitable.
You might have heard the basic factoids that are thrown around, such as “only 5% of traders make money,” or something along those lines. The actual figure is probably around there in my estimation.
But regardless, for every trader making money, there are probably 10-20 other traders coming in and losing on a consistent basis. The “casino model” may seem far-fetched and unsustainable at first glance, but it truly isn’t.
These brokers do not receive a commission on the trades that are placed through their platform, as might be claimed.
This may make it seem like the broker actually has a vested interest in seeing the trader succeed and make the trader feel more comfortable under the (mis)understanding that his or her loss isn’t the brokers gain. But this is not actually the case.
Offshore binary options brokers make money via their customers losing more money than they take in.
And technically it’s not that difficult for them to do. In a sense, binary options trading is different from casino games in that trading success is in large part based on skill. (Exceptions, of course, include card counting in blackjack, which they aim to restrict through practices such as reshuffling after each hand.)
Casinos, on the other hand, essentially never have to worry about losing in the long-run given the odds are slanted against their clients.
Casinos may incur daily or weekly losses, but over the long run their clients will lose more than they will earn. It’s a statistical inevitability that probabilities will stabilize over the long run. Hence they will earn profit scalable to the volume of money that their clients wager.
Binary options brokers slant the odds in their favor by offering payout rates less than the initial investment size and typically offer no rebate on losing trades.
Payout percentages typically run from 65%-85% on winning trades (client receives his initial investment back plus an additional fraction of it) and normally 0% on losing trades. This necessitates that a trader win a clear majority of his trades just to break even or make a profit.
A trader cannot simply go in and guess or apply a strategy that is not capable of producing results. Over the long-run it is inevitable that he will lose his money.
With break-even rates hovering around 54%-60%, it takes a pretty good trader to be able to come out ahead over the long run. Winning 60% of one’s trades is actually very good and certainly isn’t something that’s easy to duplicate.
Yet, it’s still a rate that won’t make a huge amount of money given you would typically be barely above break-even at that point. Unless that particular trader has a lot of start-up capital. In that case, a slim profit margin can still make a strong sum. But it isn’t something that a lot have.
Moreover, not all brokers’ platforms are entirely fair. Some have poor fill rates or don’t allow you into trades at exactly the price that you request.
I have even experienced trades that wouldn’t be filled until the trade actually went in my direction so I could be filled at a rate that would be further from my strike price. In the world of short-term binary options, where the winning margin is often a fraction of a pip, having a completely fair platform is essential.
Otherwise many of your trades that should have won will end up being losses, and it’s never a fun feeling when that occurs.
Where brokers really win out is due to the emotional aspect of trading, where traders who incur several consecutive losses in a row (an inevitably for anyone, no matter how skilled) frequently have the propensity to make up for past losses with a more aggressive money management strategy.
Paired with an emotional mindset, it’s very easy to blow up an account.
In a way, it would be comforting to know that your broker is essentially your ally in the trading game and benefits off your business through commission rate profit.
Alas, your success is the broker’s loss and vice versa, with a business model that is all about taking in more money than what needs to be paid back through trader winnings.