Binary Options Money and Risk Management

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Money and Risk Management with Binary Options

Trading is a game of probabilities. The sooner traders realize this, the better.

There’s not a holy grail or a golden recipe that wins one hundred percent of the times. It simply doesn’t exist.

However, profitable trading exists. Besides a trading strategy, one needs to have a sound money management plan. And to respect it.

A trading strategy may be:

– based on indicators (trend indicators or oscillators or both)

– based on a trading theory (Elliott Waves, Gartley, Gann, Point and Figure, Drummond, etc.)

– any trading approach that has a chance to generate a profit.

On top of that, when trading binary options, one needs to say not only WHERE price goes, but WHEN. This is the most difficult part of them all. Below are some things mandatory in any binary options risk management plan.

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What Makes a Good Money Management Plan?

Managing money means managing risk. Binary options risks come from three distinct areas:

– the amount to put on a trade

– the financial product and the direction

– the expiration date.

Believe it or not, the direction is the least important one. How about being bullish on a currency pair, the market moves in your favor all day and right before the expiration date makes a U-turn?

In the Forex market, this would have been a profitable trade, especially for scalpers. In binary options trading, the expiration date played a trick. Hence, we should start with it as the main pillar of a sound money management plan.

Avoid Short-Term Expiration Dates

By all means, avoid the one-minute and five-minute expiration dates. Even the hourly ones!

Trade with the end of the day, week and even month as your expiration date. After all, if someone gives you over 75% rate of return on your investment, why would you not wait a bit?

And it is not like you must wait for a week or a month. If you trade a binary option in the afternoon, end of the day is just a few hours later.

The same is true in the case of an end of week expiration if you buy the option on a Thursday or end of the month if you buy it in the second half of the month.

To make it in this market, you must think differently. Binary options brokers use all kind of tricks to get you: fear and greed are their best allies. Rationale and logical thinking are yours.

Let me give you an example: when picking an expiration date for your option, you’ll find out you can’t just pick whatever the expiration you want. You should pick one provided by your binary options broker.

It may come as a surprise to you, but brokers set these expirations dates when the market is most volatile: at daily, weekly and monthly fixings, and daily, weekly and monthly closings, or when important economic releases will hit the wires.

To mitigate this risk, set yours way beyond. The only way to do that is to avoid trading smaller expiration dates. The sooner you get this, the sooner you’ll start being a real trader.

Trade Only a Few Products

Over the weekend, look at the economic calendar for the week ahead. Check the important events, the currencies affected, and so on.

Pick only some currency pairs, for example. You don’t have to trade everything! This way, you already have a disciplined approach based on fundamental analysis.

If for example, there is an important USD event like the Non-Farm Payrolls (it comes out on the first Friday of every month), you may want to avoid trading USD pairs that week. It is known that the dollar will range until the release, so chances are the market will not go anywhere. Hence, your options will have a hard time to expire in the money.

Or, if you do trade, set an expiration that to go beyond the NFP release, like the end of month or end of next week.

Direction and The Amount to Trade With

Perhaps the most important thing is the amount to trade. After your analysis (both technical and fundamental) ends over the weekend, it is time to decide on the amount to trade.

Let’s say you have a $1000 trading account. Divide it into ten equal parts to trade every week. Therefore, for the week ahead, the amount to risk is $100.

Next, divide this $100 between the financial products you decided earlier to trade. Let’s say two currency pairs, one index, and gold. This ends up risking $25 on every instrument.

Moving forward, you don’t want to trade the whole $25 sum in one trade, do you? You’ll want to split the risk. So, split it into five different parts, for example.

This will give you five different opportunities to trade a binary option for every four financial instruments. See what we’re doing here? We’re splitting the risk. Or managing the risk, whatever you want to call this.

Conclusion

If you follow the steps ahead, you need to lose ALL your trades in ten consecutive losing weeks. What are the chances for this to happen?

Let’s do some simple math. It means two hundred options will have to expire out of the money in the next ten weeks after you started trading.

That’s improbable. Even if you know nothing about trading. But if you do know some about trading financial products, then this system is the perfect money management plan for your binary options account.

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Money Management

Money management is a vital element of trading. When applied to a high risk, high return form of investing such as binary options, it becomes even more important. Here, we explain the basic concept of money management, before expanding on the subject further, and exploring wider money strategy.

Basics Of Money Management

Money management and risk control are key for successful trading. When I say key what I mean is that money management, as a form of risk control, is how you protect yourself from yourself, how you eliminate (to the extent you can) fear and greed, how you ensure you never wipe yourself out of the market and can always come back to trade again.

It is the process of managing your total investing capital. Most people will understand that risking the entire sum in one trade is a bad idea. Likewise, many people will understand why ‘portfolio’ management includes allocation and diversification elements. Similar principles apply when managing a binary options bankroll.

Beyond those more obvious benefits however, are the ways it provides more subtle help for traders. The ability to make decisions with more clarity, the security of knowing there will be money to trade with in future and the knowledge that growth will lead to further growth without any increased risk or planning.

There are many ways to do it. Money management – true money management – is a method to control risk while allowing you the freedom to trade, and for profitable positions to make as much money as they can.

Strategies

The most widely used method of money management is called the Percent Rule:

Percent Rule

The Percent Rule says that each and every trade is always X% of your account. Cautious traders may go as low as 1%. Riskier traders may go as high as 5%, but regardless the amount it is always the same. There are a couple of reasons why this system works so well, and why so many traders like to use it.

  • It takes the guesswork out of trade size and is crucial in terms of trading psychology. There is never a question of how much should this trade be or letting your emotions make decisions for you. A fearful trader may make a trade that is too small even when the signal is really good, an overly confident trader may make trades that are too big, even when the signals aren’t great. This method leaves your mind free and clear to focus on what is really important, the signals and how to trade them.
  • Using a percent rather than a set amount means that the size of your trade will grow, or shrink, with your account. This means that if you have a losing streak you will make successive smaller trades. No one trade ever large enough to wipe you out and no losing streak so bad it will wipe you out either. On the flipside, as your account grows so to will the % you trade so that your profits will grow too. An amount like 5% may seem small when you are trading $20 to make $36 but it’s no different than trading $2000 to make $3600, if that is what 5% of your account is.
  • The Percent Rule doesn’t so much boost confidence as removes an obstacle that may shake what confidence you already have. At the same time it keeps your account safe long enough to gain some experience, and by extension the confidence that comes with achieving a goal. When it comes to trading, confidence is what pays the bills, anyone can spot a signal but only a confident trader will trade it and be able to walk away without spilling a tear if it loses.

This is how it works. If your first deposit is $500 then a 5% trade size is $25. To keep things simple I would trade $25 until the account was $550, then the trade size ups to $27.5. If you lose then the account falls to $475 and you reduce your trade size. In this case that would be $23.75, if your broker doesn’t let you enter pennies into the trade amount then I would round down rather than up to err on the safe side.

When it comes to adjusting your trade size it is just as important to raise it as it is to lower it, you don’t want to cut yourself out of profits you should have made by trading only trading 3% or 4% of your account when you should have been trading 5%.

If you become emotional over losing money and decide to recoup those losses by trading larger and larger sizes (e.g., a Martingale-like strategy), you will inevitably crash and burn eventually and end up with nothing. Martingale strategies have permanently ended many trading careers.

You will find that many of the best traders in the world scoff at the Martingale concept and for good reason. They never turn out pretty and fundamentally restrict the maximum trade size you can make. For instance, the current maximum trade size on 24option is $20,000, but investing $1,000 per trade would be imprudent in that you wouldn’t be able to sustain more than four losses in a row before you would no longer be able to recover those losses (and be $31,000 in the hole assuming a simple double-up type of Martingale).

Systems

While it’s important to set personal rules (e.g., trade only with the trend, no more than three trades per day) and attainable short-term goals (e.g., achieve an ITM percentage of 60% or higher), which may differ from those of other traders, I feel a big mistake is to set a monetary goal that must be met by a certain date or, worse yet, every single day.

It is very difficult to become emotionally detached from your trading when certain profit goals are wrongly taking priority. I used profit goals when I first began trading, and I found that they were nothing but a distraction that led me to make bad trading decisions and losses I could have avoided.

Calculator

Calculating your risk in binary options is actually very easy. With the 5% rule, for every $1000 in your account you can afford to expose $50 at any single time. This means all trades are $50 until you begin to win or lose and have to make an adjustment. So, after reading this your first step is to identify and sign up with a broker that will allow you to place trades within the confines of your acceptable risk appetite.

The calculation needs to be based on your appetite for risk too. A 5% plan is fine, but is probably still at the higher end of the risk scale. A 1% per trade strategy will reduce risk even further. This might be helpful for those just starting out in binary options. As noted above however, the minimum trade size available with your broker, may dictate the smallest percentage you can trade with.

Risk Management for Binary Options Trades

Risk Management for Binary Options Trades

Binary options, just like any other form of financial trading, has an element of risk involved. You could lose all or most of your money in an instant if you are careless or greedy. As such, the concept of risk management is one that every binary options trader should take very seriously.

The generally accepted risk management rule adopted universally by professional traders is that no more than 5% of the account size should be exposed to the market at any given point in time. What this simply means, is that if you have a $1000 binary options account, you should not have more than $50 in the market at any given time. Trading anything more than this is extremely risky, especially as binary options is an “all or none” type of market.

It is not like forex where you can cut your losses early if you see that you are probably in a bad trade. In binary options, unless your broker is the type that gives back 15% of invested capital in trades that are out of the money, or you have the opportunity to sell off the contract before expiry (variable options), then you are out of luck if your trade goes bad. So you need to be sure that you properly utilize the only means of controlling risk available to you.

Calculating your risk in binary options is actually very easy. For every $1000 in your account, you can only afford to expose $50 at any single time. So your first step is to identify and sign up with a broker that will allow you to place trades within the confines of your acceptable risk appetite.

Binary options brokers have made this very easy, because the moment a trader pushes the button to purchase a contract, the trader is immediately shown the cost of purchasing that contract. He cannot lose more than what he spent purchasing the binary options contract, so for every contract purchased, the amount at risk is known and the potential reward is also known. This enables the trader to do what is necessary in order to keep his risk within acceptable limits.

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This is a typical trade for a $5,000 account. The expected payout for the Rise/Fall trade is $500. In binary options, payouts are made up of your invested capital and your profit. So for a payout of $500, this trade will cost the trader either $267.67 or $268.70, which is approximately 5% of the account size.

However, this is for a single trade. If you want to take 2 trades, then you need to split your payout into two, and then select a trade that will reflect a 50% investment of the expected payouts from both trades.

The essence of all this is to protect your account from the devastating effects of losses in a single trade where too much capital was invested. Imagine a situation where a trader with a $5,000 account tries to hit a $2,000 payout and invests $1000 into a trade. If that trade is out of the money, then he has lost 20% of his account in just ONE trade!

You may think this is over the top but you will be surprised at how often many retail traders succumb to the destructive emotion of greed and try to dare the market in this manner. Do not fall prey to this.

We all hope to win but the truth is that there will be times when we make bad trade calls. It has happened to everyone; even the great Warren Buffett lost millions in October 2008. But what separates those who re-emerge as successful traders from the rest is the ability to control their risk. Control yours too.

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    2nd place in the ranking!

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