Binary Illusions


Some 10 years ago any attempt to mention financial markets in a non-professional milieu inevitably hit the wall of skepticism: «Forex again?! Oh, spare us this rubbish, please!

I would like to draw reader’s attention to a particular issue: this common reaction is based on the misconception known as fallacy of composition where the negative attitude towards Forex is inferred upon financial markets in general. Like it or not, that kind of attitude distorts the reality dramatically and we must figure out how to avoid detrimental generalizations.  

It is obvious that this reality switch is rooted in the heavy advertising run by Forex brokers all over the world. The negative attitude is just an epilogue to the personal experience: thousands of people have had a chance to relish the pleasures of easy money promised by Forex and shared their impressions with their buddies. As a result, the relations between the stock market and laymen are spoiled for years ahead.  

Today the title of the ‘major public enemy’ has been overtaken by Binary Options (BO) brokers who even outclassed their Forex peers in the art of fallacy of composition: because of binary options laymen hate the stock markets and trading as never before.  

I assume there is no need in reiterating trivial warnings against the scam of brokerage kitchens whose entire setup prevents clients from making money. These warnings are superfluous because both Forex and BO kitchens denounce themselves through the poor results of their customers who spread the bad news with the speed of light.  

At the same time, I am interested in defending the reputation of authentic financial markets where listed stocks, futures and standardized options are traded instead of currency pairs and binaries. With this in mind I will try to demonstrate how the market of binary options contradicts the very premises for successful trading, thus turning itself into an unpredictable game of chance.  

The trading at the established markets (stocks, futures, options) is driven by an objectively justified premise that one can achieve a statistical edge based on knowledge, experience and — most important of all — ability to analyze the reality. Without this premise the financial market is indistinguishable from the casino and would have never had a chance to act as an intermediary for the entire world economy.  

A statistical edge means that our revenues from trading might exceed our losses not only due to a proper money management but mostly owing to the fact that the number of the winning trades surpasses that of the losing ones.  Our belief in statistical edge is based on the two objective observations. Firstly, we make trading decisions while predicting changes in certain parameters such as price or its volatility which measures the amplitude of price fluctuations in time. These parameters reflect the reality of financial instruments which in their turn are derivatives of objective business activities of their issuers. As such, they comply with the universal law of determinacy applicable to both nature and human society. The most obvious form of determinacy we know is cyclicity.

The determinacy asserts the presence of the cause-effect relationship which results either from a direct influence of external factors (economic, political etc.) over the price and volatility or indirectly through the refraction of these factors through the chaotic nature of financial instruments.  

Direct determinacy can be traced with the help of fundamental analysis. Indirect determinacy is efficiently revealed by means of technical analysis. Without going further into details it is important for us to realize that both technical and fundamental analyses give us statistically reliable proof of existence of such determinacy.  

Over twenty years of my personal trading experience make any theoretical talk about potential unpredictability of the financial markets meaningless and irrelevant. The extent of this irrelevancy can be easily measured: for instance, in the two last months preceding the writing of this article I have had a stretch of 27 consequent trades at the futures market out of which 26 were profitable and only one brought loss. What unpredictability of markets can we talk about? The second observation which the statistical edge in trading is based upon is rooted in standardization of financial instruments and strict regulations of trading process which are provided by exchange authorities.

The practical benefit of this regulation consists in maximum possible avoidance of manipulation which easily destroys any statistical edge based on determinacy and cyclicity of the established markets.  All modern full-fledged exchanges — from CBOE and CME to LSE and SEHK — provide this kind of solid standardization and regulation, thus it is only logical to begin the comparison with the world of binary options from this very aspect.  First and foremost, there is no such thing as binary options market in the strict sense of the word.

All trading is done not at exchanges but at the so called kitchens similar to the Forex ones i.e. in artificial sandboxes created by the brokers themselves. What is promoted as supposedly binary options exchanges — e.g. Nadex or Cantor Exchange — are still proprietary playgrounds whose level of standardization and regulation has nothing to do with the real bourses.  The direct consequence of the sandbox model of market is a lack of continuity in traded instruments. In our case — in binary options. They are discrete, they don’t create an unrestricted financial space, they are deprived of determinacy and as such, they don’t obey universal laws of cyclicity simply because they have nothing in real world to correlate with. There is no objective reality in binary options other than that of a spinning ball in the hands of a skillful croupier.  

Let me give you an example of the theory above. If we take a standardized listed option written against the futures contract on a currency pair, let’s say, EUR/USD, we can easily detect a chain of determinacies. The option derives from futures, the futures derive from the real state of two sovereign currencies — Euro and US Dollar. The presence of these determinacies allows us to analyze the behavior of all subordinate realities in search of cyclicity and other forms of dependency which instead will lead us to an accurate forecast.  

When we take a binary option misleadingly called EUR/USD we should realize that this instrument has nothing to do with either the futures of the same name or with two existing currencies. This binary option represents an independent and undetermined reality whose lifespan is measured not in weeks, months or years as regular options do but in minutes — mostly 5 or 15!  

 

Is there a way to analyze this kind of reality? There is no such way! What cyclicity can we discover in it? There is no such cyclicity. Not incidentally, you won’t find a single mention of analysis in public ads of binary options which talk only about «simplicity and «big wins: «Bet 10 bucks and get 18.80!  

Now let’s have a look at the binary options from the perspective of market regulation and protection against manipulations which destroy statistical edges of an intelligent trader. Unfortunately, the sandbox nature of a binary options market makes irrelevant the perspective itself. Discussing regulation and protection of the trading space which lacks links to reality is meaningless. It is obvious that similar exchanges will lack regulation and protection of traders by definition.  

There is even much more to say: common sense suggests that the format of sandbox is initially employed for the purpose of manipulating the financial instruments with no relation to reality and a life span of 5-15 minutes. May I remind you that a binary option is profitable for the buyer only when its price is above (for a call option) or below (for a put) the strike at the moment of option’s expiration. Now, with a complete lack of control on behalf of the trading public, is there anything that could prevent the binary option broker from jerking the price on the software level in the direction opposite to what makes the client win? It looks like a rhetorical question to me.  

Let’s draw a conclusion. It was obvious for a long time that binary options and binary options brokers have nothing to do with financial trading. This is pure casino in the direct sense of the word. What makes the things even worse it’s not a real life casino but a virtual one where the croupier can influence the direction of the roulette ball with a spin of the wheel.  

That’s why the most important thing today is preventing the world of binary options from discrediting financial trading. In order to achieve this goal, we must oppose any attempt of binary options brokers to draw analogies between their wonderland and the genuine exchanges and financial instruments. Unless, of course, we want to see the final exodus of private investors from active markets to bank deposits.  

Sergei Golubitskiy can be contacted at EXANTE

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