What Is Risk Management for Binary Options?
Editor’s Note: The following article is an introduction to Risk Management including some tips from our pros and a look at how trading binary options can be like gambling. Nevertheless, I believe it’s not enough just reading about risk managing, so this article is merely a milestone in a newbie’s quest to understanding and enacting efficient risk managing tactics and long term strategies. For a newbie to actually learn Risk Management, he needs to learn from a true PRO and lots and lots of experience. Fortunately, we have our PROS to teach you how it’s really done.
What Does Risk Management Mean?
Risk management is the most important part of trading. It is without doubt that you will lose at some point or another. No matter how good you are or how long your streak is you will lose eventually. Without proper risk management it is possible to wipe out your account without even meaning too. You don’t have to make overly risky trades, although any trading is risky. All you have to do is make a short string of losing mismanaged trades to put your account at risk.Position sizing is the pillar of a good risk management system.
It’s easy to sit and say to yourself…self, I have a good risk management system and I will be profitable over the long term. It’s much harder to actually use it. It takes serious will power and self control to properly utilize a good risk management system. Every single trade has to be made according to your rules. When there is no signal or no room in the account for another trade you have to be able to walk away. At the same time when you are riding the high of profits you have to be able to stick to the rules as well. In between, when you get bored, you have to stick to the rules.
Risk management is important for many reasons but one is first and foremost. You have to be able to manage risk or you will get wiped out. If you get wiped out you can’t trade and when you can’t trade there is no chance of your account getting larger. Risk management is hard to follow but remember that it is better to be able to make a small trade than no trade at all.
How To Apply Risk Management To Binary Options
It is easy to apply risk management to binary options. The predetermined losses make it simple to position size. All you have to do is to multiply your account by the percentage you want to risk. Assuming you have a $1000 account and you want to risk 5% you will do this:
$1000 * 5% = ($1000*5)/100 = $50
In other words, you will open your trade with $50 and that’s the amount you will lose if the worst case scenario occurs.
After that it comes down to your analysis and strategy, just like any other form of trading. The better your analysis, the stronger your signals the better your risk is managed. You never want to blindly enter a trade be it on a hunch, a tip or your horoscope. Binary options are highly speculative in nature and require proper risk management.
Few Risk Managing Tips for Newbies Before Trading
First Step: get educated. Yes, that is a risk management technique! Don’t believe everything brokers say, don’t believe trading is easy and everybody can do it. Do you see millionaires everywhere? I guess not. If things would be that easy, we would all have butlers who own a Rolls Royce and have butlers of their own.
Second Step: use common sense and do not invest more than you can afford to lose or more than your account can sustain. I cannot tell you an exact percent of the entire account that you need to risk on one trade because this is something that depends on each trader’s risk appetite and skill, but think of it this way: when things go bad and you hit a losing streak, how big is that? Then adjust your investment on each trade in a way that your account can live through that losing streak.
Third Step: Follow Trading Pros Risk Management Strategies. If you don’t know a PRO, you can find Risk Managing Strategies Here, or Consult with ThatSucks.com (former BinaryOptionsThatSuck.com) PROS on Forum.
Defining Your Binary Options Risk Tolerance
In options trading, we define risk as the probability any given trade will create an unsuccessful result and generate financial losses. Of course, this is true any time a position, as there is no trading method can can prevent losses 100% of the time. It is always important to start with the known potential for risk any time a new position is being considered, so that traders can be prepared for the worst case scenario (and not lose an entire trading account in the process).
Not all trading strategies use the same rules so the first thing to do is to assess your own trading style. Are you an aggressive trader (willing to risk large amounts in order to generate large gains)? Or are you a conservative trader (looking to reduce risks and generate stable gains over time)? In traditional trading, some of the classic ways of reducing risk include hedging (the practice of taking offsetting or uncorrelated positions), or stop losses (which automatically close positions after unfavourable market moves).
Trading with binary options is a very different scenario, however, and most of the risk management techniques are focus on initial cash outlays and proper fundamental/technical analysis for trade entries. In the first area, this means keeping position sizes manageable, and keeping the number of open positions to reasonable levels. For aggressive traders, no more than 5% of your account size should be risked at any one time. This means that if you have $10,000 in your trading account, the combined potential losses of all your open positions should never exceed $500. Most experienced traders, however, consider this number to be too high, and a majority of these traders never allow their risk exposure to exceed 2-3%.
Buying Low and Selling High
Other aspects of risk management deal with your trade selections themselves. If we look at the old market maxim “Buy Low, and Sell High,” some valuable lessons can be learned. When we buy assets (using CALL options) at lower prices, there is a decreased likelihood that prices will fall further. In addition to this, there is less “room” for prices to fall further, meaning that there is less open risk for bullish trades. Conversely, when we sell assets (using PUT options) at high levels, there is less potential for prices to rise further.
When we wait for these scenarios to unfold (before entering into positions) there is reduced risk that the trade will end in an unfavorable direction. This logic disagrees with the basis for some types of trading strategies (such as breakout strategies). But when looking at back tested data, strategies that rely on breakouts succeed at roughly 30%, so your total risk for losses can be reduced when we avoid these strategies and use the classic market logic to buy low and sell high.
Using Roll Over and Early Exits, Risk Management Tools
Some brokers are more flexible with the ways open positions can be managed. One tool for avoiding risks can be seen with the Binary Options Rollover feature, which allows you to postpone the expiration date of your trade. For trades that are unfolding in the wrong direction (out of the money), there is still the potential for gains if you can extend your expiration date, and these features can help to reduce risk of loss. Another feature to consider is the Early Exit (which is given different names by different brokers). In these cases, traders can close a position before the contract expiration and “cut” potential losses if it looks as though the trade will not be profitable before expiration. For new traders, all of these factors should be considered because the risk of loss is possible in every trade you will place.
The Geek Reveals: How I Manage My Risk in 3 Steps
It is without doubt the trading any financial derivative is risky. Binary options are no different. Contrary to what some would have you to believe they may carry less risk than other forms of trading if used properly. An out of control margin account can lose huge sums in minutes if not watched; a binary options account can only lose the amount traded. Even with that protection it is still necessary to use your judgment, control your emotions and manage your risk. Over the last ten years I have learned many lessons, some of them the hard way. In that time I have developed my own system of risk management just like each of you have done or will need to do. I don’t think it is possible for one persons system to work perfectly for everyone. We’re all different and have different needs and view the market in different ways. I do think that all successful risk management systems have a few of the same characteristics.
Road to Success – First Step Start with Education
The first step in my risk management is education. Not just about education about trading but about what the market is and what makes it tick. I must know everything I can about it and how it reacts to different events. This knowledge provides the first edge for me and other traders and it’s what helps elevate trading from gambling to speculating. Speculating is defined as the practice of attempting to profit from short term fluctuations in price movements but it is so much more than that. In order to actually profit from those fluctuations you have to know that market so well you can anticipate them. This requires in depth fundamental and technical analysis and these require education.
Second Step – How Much Are You Willing To Risk?
The next step in my risk management system is position sizing. This is the practice of only trading small, measured amounts with each trade. By keeping trades small and making trades whenever my system allows I am better equipped to take signals when they appear and will never wipe out my account on one trade. I like to follow the 1% rule in my personal trading accounts. Sometimes less. This means that I can make trades and never lose more than one percent of my account value. This may seem small but over time my account will grow and so will that 1%.
Third Step – Choose Your Strategy
The last part of my risk management system is strategy. A strategy is a systematic way of generating buy and sell signals that are measurable, repeatable and predictable. I use a combination of strategies and indicators that I have come to trust over time. They generate some signals independently of each other but give the best signals when they all agree. I like to call this a convergence of convergence. Sometimes I get a convergence of divergence, another power signal.
The End-But It’s Just The Beginning
These three steps combine to limit and manage my risk. I reduce exposure, employ a strategy and take a well educated position on where the market is headed. I prefer to keep my trades on the daily charts because I find them to be more reliable. It is possible to utilize shorter time frames but the best way is to use at least three. Regardless of how you approach risk management it will take practice and experience to fully realize just how powerful a tool it really is.