The fast-paced, speculative nature of binary options isn’t for the faint-hearted. Traders must always face the potential of losing money for each position they initiate. Hence, learning about risk management is non-negotiable.
Risk management involves using different methods to minimize losses while ensuring a healthy upside over a series of trades. Given this topic’s flexibility, traders use many techniques.
Key Facts on Binary Options Risk Management
- Risk management in binary trading aims to minimize the negative impact of losing investments by implementing strategies to handle losses effectively
- The greatest risk in trading is the risk of ruin, which is the potential of losing a significant portion of capital in a single trade
- Traders use risk management techniques to ensure losses are manageable, allowing them to preserve their bankroll for profitable opportunities
- Risk management principles include using disposable funds, allocating positions conservatively, and keeping per-trade risk consistent to mitigate losses
- Strategies for risk management in binary trading include early close and rollover, hedging, doubling up, Martingale, and anti-Martingale, each with its own risks and benefits
What Is Risk Management in Binary Trading?
Risk management refers to measures or concepts to minimize the negative effects of losing your investment stake in binary trading. As with other markets, no trader has near-perfect predictive ability.
Many traders overlook this fact, so they cannot be consistently profitable. The greatest risk in most traded markets is the risk of ruin or the chance of losing a substantial amount of money in a single trade.
Risk management is there so that losses are manageable without greatly comprising a trader’s bankroll. In doing so, they have enough remaining funds to capitalize on situations that are gainful for them. Risk management should form part of a binary trader’s trading plan, ensuring they are prepared financially and mentally for the worst-case scenario.
Many experts believe risk management with binary options is easier than with other trading styles. This is because binary options have an undefined upside and downside (even with stop losses).
The greater the returns a trader seeks, the more financial risk they take, with no promise of achieving their desired profit. They must also consider different outcomes, which may not be pure losses and gains.
Meanwhile, the risk and reward are set in stone with binaries. It’s either/or, with no gray area to worry about.
Video Explanation of Risk Management and Protecting Your Money:
Risk Management vs Money Management
Traders across all markets often use risk and money management interchangeably, as these are intertwined concepts. Hence, few differences exist between the two, especially in the context of binary options.
Generally, money management refers to position size and the amount a binary trader allocates per trade in monetary terms. Meanwhile, risk management involves several techniques to manage different trade outcomes.
In most markets, this would be using a stop loss, trailing your stop, breakeven stops, scaling out, etc. However, given the ‘all or nothing’ nature of binary options, many of these actions don’t apply. The main risk is failing to predict a binary trade’s outcome.
(Risk warning: Your capital can be at risk)
The Principles Of Good Risk Management
While the strategies (covered in a moment) for risk management vary, the principles remain consistent. It’s worth learning about them before diving deeper into the techniques.
Using Disposable Funds
The statement “only invest money you’re willing to lose” may be clichéd – but it’s true. Many binary options traders enter the markets using funds they should spend on urgent life expenses. Binary options, like other markets, come with huge financial risks.
Trading with non-disposable money often makes traders’ decisions more emotional than logical. Meanwhile, disposable funds allow traders to be free of attachment to their capital, fostering a calmer, focused mindset.
Conservative Per-Position Allocation
Generally, experts recommend traders allocate at most 1% of their trading capital for every trade. So, someone with $1000 as their balance would bet $10 per position.
However, binary speculators may consider 0.5%. The capped, lower upside of standard binary options means that traders must win more positions to ‘break even’ and compensate for their losses.
Hence, allocating a tiny portion of your overall account is paramount. In doing so, your recovery time is shorter, unlike in scenarios where you risk a large chunk.
For context, it takes an 11.1% gain to compensate for a 10% loss in trading capital, a 42.85% gain to cover a 30% trading capital loss, and so on. It’s clear that the more you lose, the higher your gains must be to return to your previous point.
Keeping Your Per-Position Risk Consistent
It’s all well and good to remain within 1% or 0.5% per trade. However, it’s easy for traders to quickly ramp up this allocation after a few successful positions due to overconfidence. Hopefully, your positions in monetary terms steadily grow over time as you become more profitable.
What is dangerous is having a drastic change from a conservative allocation to one that could lead to a massive loss or wipeout. So, even with growth in your trading account, binary options traders should adjust accordingly and keep their bet amounts reasonable.
Having Realistic Long-Term Profit Expectations
Binary options have gained a reputation for quick profits, leading some to believe it’s a vehicle for astonishing returns. As mentioned, standard binaries generally have a lower upside, usually 80-95% of the bet amount.
The only way to increase the payoff is to switch to more complex binary options like in/out, touch/no, and ladder. Otherwise, having realistic long-term expectations prevents over-trading and unnecessary positions.
Binary options traders should consider other trading forms to supplement trading opportunities.
Techniques for Proper Risk Management in Binary Trading
With the principles out of the way, let’s get into the meat of the different risk management strategies in binary trading. Each technique doesn’t only revolve around minimizing losses but maximizing gains.
Of course, the most crucial strategies are those that reduce your downside, while those seeking to increase your upside may produce terrible results.
Early Close And Rollover
It’s worth noting that these elements are only available with some brokers. They often only apply to binary options with expiry times above 30 minutes, unlike short-term ones like 1 minute or 5 minutes.
The ‘Early Close‘ feature allows one to close a position before expiry. The result should be a lower profit or a smaller loss, depending on where the trade is at that time. Using this mechanism is good when you take a smaller loss than you would have incurred without it. Yet, the opposite is true; closing too early also means sometimes making less than the initial projected gains.
Then, there is the Rollover (or Extend) feature. As the term suggests, it allows binary options speculators to add more time to their positions (at a premium). Traders often use this when their trade is ‘out of the money’ or losing. However, the feature may apply to grow the profit potential.
In both cases, the broker applies a time limit of how long you can rollover.
Hedging
Hedging is the practice of offsetting losses by taking two opposite positions in the same or related market. The key is to ensure the correlations between these two trades don’t double your financial risk. Hence, the simplest way is taking two positions (a ‘buy’ and ‘sell’) in the same binary options trade.
Various hedging strategies exist that produce different consequences. Usually, the net outcome of buying and selling a basic binary options trade like the high/low is zero. This is when one position sees you ‘in the money’ while the other sees you ‘out the money.’ In certain scenarios (depending on the strike prices, position size, and type of binary options), some traders could generate a profit on both trades.
While hedging reduces losses when used properly, it impacts profits similarly. Your broker may also charge extra transaction fees.
Another form of hedging may be diversifying into other non-binary markets like forex or traditional options. It’s common for traders to trade binary options as a secondary choice, allocating a small part of their capital while the rest is with a different, more profitable instrument.
Doubling Up
This self-explanatory feature allows traders to ‘double up‘ the profit potential for their current position. It’s only available with certain brokers on specific binary options, which must be ‘in the money’ or already profitable.
Typically, a trading platform allows you to add the doubling mechanism five to ten minutes before expiry. Adding it means that you double the potential profit and liability of your existing position.
You gain twice your payouts if that trade meets the original conditions of your initial contract (e.g., being above/below the strike price before the expiry). However, you lose twice your investment if the opposite occurs.
This strategy is best once you have a string of profitable positions.
Martingale (And Anti-Martingale)
The Martingale is the riskiest technique for any traded market, a tried-and-tested method that remains controversial. It revolves around doubling your binary bets after each losing position, hoping that a single trade can recover all your losses, resulting in a net profit.
So, if you plan to allocate $10 per trade, you will double that to $20, 40, 80, etc., until a winning trade comes along, which will be large enough to compensate for your losses and then some.
Martingale is highly risky because you can lose your entire account. It’s hard to statistically determine which position in a series of losing trades will be profitable. Martingale also works on the assumption that traders have an infinite amount of capital, which is impossible. Any traders attempting Martingale should be quite experienced and risk a lower-than-normal percentage of their overall balance.
The main problem with Martingale in binary options is that you often win less than 100% of your stake. This means you technically have to bump up your bet by over 2x, which increases exponentially after each losing position.
A variation of Martingale is ‘smooth Martingale,’ where traders increase their bets after losses by less than 100% (say 20% incrementally). While less risky, you can still lose a substantial amount of your capital.
On the flip side, we have anti-Martingale (or reverse Martingale). Instead of doubling your bets with traditional Martingale, you reduce your bets by 2x or half after a losing trade. The obvious downside with this method is that it would take you much longer to recover.
Alternatively, some traders double their bets after each win until a loss occurs, at which point they return to their normal allocation. Speculators can combine both scenarios by doubling their investment size after each win and reducing it after each loss.
Conclusion: The Importance Of Risk Management
It’s natural to be attracted to the prospects of generating profits in binary options. But paying little to no attention to the downsides has catastrophic effects.
The best football team begins with a great defense instead of a great offense. Experts agree that profits have more elements of luck and other uncontrollable variables. Meanwhile, the potential for loss is the only element within a trader’s control.
The importance of managing risk cannot be understated. Yet, it’s key to choose the best strategies. While methods like hedging and doubling up offer unique perks, it boils down to applying them correctly to ensure optimal results.
(Risk warning: Your capital can be at risk)
Most asked questions about risk management in binary options:
Which is the most dangerous risk management strategy in binary options?
Martingale is the most dangerous risk management strategy because it can happen that you lose too much trades in a row and you can not keep up bigger investment amounts.
Is there a binary options risk management calculator?
Yes, these are calculators for different purposes like gains vs losses, martingale risk-to-reward, per-trade allocation, etc. It’s best to use these instead of manual calculations, which are time-consuming and not always 100% accurate.
Where can I learn more about binary options risk management?
Brokers and third-party education websites can provide more details about risk management in binary options.
How risky are binary option trades?
Binary options are quite risky due to their fast-paced nature and given that the payouts are generally less favorable than other instruments.
What are some key principles of good risk management in binary trading?
Key principles include using disposable funds, allocating positions conservatively, keeping per-trade risk consistent, and having realistic long-term profit expectations.
