A binary option is a perfect example of a doing or dies type of trade. You risk a particular amount within a period. You either get a fixed return or lose your investment depending on the increase or decrease of the underlying asset after the stipulated period.
However, back in 2009, the Nadex exchange in the United States introduced options that allow traders to purchase or sell an option at any moment until it expires. This opens up various eventualities, as a trader can quit for less than the complete loss or profit.
But does this mean that the risk is any low? No, you will always be encircled by the high risk of losing a considerable amount of money while investing in binary trading options. Therefore, proper strategy and understanding of risk management are essential. In this article, we will explain everything you need to know about Binary Options risk management.
What is Risk Management?
Risk management can be defined as the small steps you need to follow while trading, ensuring your financial management and saving you from the huge loss of money.
Either you are a professional trader or a trader with retail accounts, or even a day trader, risk management is equally crucial for you since you must have an affordability limit.
Risk management for every trade is different. You need to apply strategies as per your needs and the risks you are bearing while trading. An effective risk management approach allows you to evaluate prospective gains and losses, allowing you to make an informed decision about whether to place a transaction.
However, there are a few common points you need to consider while making a risk management strategy.
- Thoroughly consider all the possible outcomes.
- Always use strategy while trading. Do not bring emotions or relations in between.
- Increase your exposure by diversifying it.
- While trading, make sure to use verified products that you can trust. In the case of Binary trading, you must go for regulated brokers rather than non-regulated ones.
- Do not blindly do what the crowd is doing. Analyze all the perspectives before proceeding.
Strategies for Binary Options Risk Management
In comparison to other trading options, binary options trading makes many things easier to manage, which is a benefit if you are new to the trading career. However, this does not mean that you are not at risk.
The more you invest in binary options for a greater amount in return, the higher is your chance to lose. Thus, there is a need for proper risk management strategies before you start investing in Binary Options.
#1 Choosing The Proper Trade Size
If you are consulting brokers for your Binary option trading, you may notice that the minimum trade size would vary from broker to broker.
However, when this is combined with what is required for account funding capital and the maximum allowed risk for each deal, you get a sense of how much exposure the account can handle to meet acceptable risk management requirements.
Most of the authorities would agree that you should apply a risk exposure of 3% to your account maximum at a time. For instance, if your broker is advising you to go for %30 trade size, then don’t follow them blindly, instead calculate the amount required to fund your account and the capital you want to trade and make sure the amount is not more than 3% of your account size.
In this example, if you are using $30 as minimum capital and aiming to have two trades at once of this size that is $60, you will have to make sure that you have the minimum of $2500 in your trading account.
It is crucial to understand that the binary options market is unleveraged, and thus, you are responsible for all the capital you are investing in the trade. If only you can afford $1000, then only you should go for investing $30 at any given time.
But, you can increase the investment when you start to grow and become a regular investor in Binary Options. No strategies of minimum loss are going to work when you are new to the trade.
Thus, it’s better to risk the least amount you are ready to lose without much regret. After you gain some experience and money as such, you can increase the risk for better outcomes.
#2 Applying Trade Psychology
Trading is a psychological event since money is involved, resulting from our human endeavors aimed at making a livelihood. So now, if you lose a trade, there would be an urge to recover the lost amount as soon as possible.
If you see this from a trading perspective, there is only one way you can achieve this: increasing the size of your trade than the previous one in the hope of getting a greater outcome in case the trading goes in your favor.
However, you cannot be certain about winning. There always remains a 50% chance to lose. In case you lose this trade as well, your loss will be in bulk. Therefore, there is a need to link trading psychology with risk management.
Psychology works in the following way. When you see that you have lost a certain amount in your previous trade, even after getting an urge to invest more to recover the loss, you need to reason and choose to decrease the trading size than the previous loss.
This is beneficial for two reasons. In the first circumstance, if you lose the money, you won’t regret much since the amount is even lesser, and in the second circumstance, if you win it, it will help re-establish your confidence to trade.
The above was just one example. Similarly, you can study trading psychology for every instance. You can make the best decisions for trading-related risks like the best moment to enter a trade, the best expiration time to use, whether or not to roll over, or double an investment, and so on.
#3 Understanding The Underlying Risks Associated With A Binary Options Trade
If you are new to Binary options trading, you must be wondering that the chance of winning and losing the money in the binary options trade is 50:50. But this is not the reality.
If you do research work, you will know that the loss in binary options is more than winning. In a traditional up or down trade, the payout is rarely 100%. In maximum luck, you may get 90% of the amount. But typically, traders only get 70% to 80% of the win.
On the other hand, if you lose the trade, you will lose 100% of your money. There is no compensation. Even using the loss return function reduces the payout in a successful transaction while returning some of the invested funds in the event of a lost deal.
As a result, risk management will include analyzing the data in greater depth and knowing what methods to employ to tilt the maximum profit in your favor.
For example, losing $100 in three consecutive trades will take you four wins to counterbalance the loss. So, when you invest, you must do it judiciously, considering the great chances of success.
To understand this trait, we can use the Alcoa case study. Even when the winning chances were low, the trade that was made was Up—a falling wedge-formed, which is a bullish reversal pattern.
Positive news of a new arrangement with Ford Motors, which would lead to increased demand for its products, raised the stock in question. As a result, the fundamental news backed up the technical play. However, with one-hour expiration, an up trade would have sealed the deal for the trader.
This was the perfect example to demonstrate that trades, as assured as the above one, means that the money is not put at risk by betting on trades that have not been thoroughly researched or when the setup is not as apparent as this one.
How to Determine Risk on a Trade?
The risk in the Binary Option is always a fixed amount. For instance, if you put $10 in binary options trading, then the maximum amount you lose is $10 only. Whereas the profit can be more in case you win.
Therefore, some brokers offer a rebate on losing trades. This means, if you invest $10, the maximum loss can be $9 only. It can be explained with the following formula.
Maximum loss+ Rebate= Trade Risk
In the above circumstance,
-$10 + ($10 x $10)= -$9
Currently, Nadex Binary options do not have rebates on losing trades but, there is an alternative to complete loss. For example, in Nadex, if you buy an option at $70, and it drops to $50, you can have the option to sell for a partial loss. This way, you won’t lose it entirely after dropping to 0.
However, when the Nadex option expires, it will be valued at 100 or 0. As a result, when calculating your risk, you must consider all the subsequent scenarios.
Determining Position Size on a Binary Trade
Till now, it must have been clear to you about the maximum trade size to use while buying an option in the Binary option.
However, there is an exception. Your trade size also depends upon the broker. If they are offering a rebate, then you can increase your risk and invest more. But if there is no rebate, stick to the 3% policy strictly to avoid huge losses.
Now let’s talk about if the broker provides a rebate. To understand this, let us consider that your broker is providing a 10% rebate. So if you were going to invest $50 without a rebate, you could now invest $55 because you have a rebate.
Now, if you lose the option, you will still have your $5, and the loss amount will be the same as $50, which is still the 2-3% of your trading account balance. But, if you win, you are going to win it whole. So you get a double benefit.
Frequently Asked Questions
What is the best strategy for Binary Options?
You can use many strategies to decrease the risks, like going with the trends, the straddle strategy, the Pinocchio strategy, following the news events, the candlestick formation pattern strategy, and many more. Make sure to acknowledge yourself thoroughly before putting your money at risk.
How do you win at 60 second Binary Options?
There is no such thing as the finest 60-second binary options strategy. To profit, a participant must anticipate that the price of a purchased option will move by at least one point in 60 seconds compared to the initial price.
Which Binary Options Broker is best?
There are many regulated and non-regulated brokers you can consider before binary options trading. Some good ones are a pocket option, Nadex, IQcent, Quotex, etc. You can choose your broker according to your needs and strategies. All the brokers excel in their particular field. Thus, choose as per your need.
The main two elements of trading success are generating positive returns and maintaining risks. It is not enough to develop a plan that delivers a favorable return if we do not appropriately manage our risk. Therefore, these elements go hand in hand.
For an experienced trader, it is quite simple to get the psychology of trading. However, the new traders face real difficulties. Nevertheless, it should be kept in mind that many successful binary options traders we see today were once a beginner which means that it is also possible for you to attain heights. All you need is the right strategy at the right time.
If you are still insecure about losing your money, just remember the above steps and play smartly. Never exceed the trading size limit and thoroughly study the trading psychology. Moreover, learn the appropriate ways to trade and learn more about the brokers you are using for binary options trading.
All the above strategies together can give a positive outcome. Even so, the risks remain the same, but the chances of you losing bulk amounts become less.