Managing your money wisely is just as important as the trades you make in binary options. Even the best trading strategies can fall short without a solid money management plan.
In this guide, we’ll break down essential money management techniques that can help you protect your capital and improve your chances of success in the markets.
Key Facts to Know About Money Management:
- Money management uses numerous techniques to limit losses while finding ways to promote capital growth with minimal risk
- Using discretionary funds, moderate allocation, and realistic expectations are money management fundamentals in binary options
- Popular strategies include the percent rule, doubling up, Martingale, Fibonacci, and the Kelly Criterion
What is Money Management in Binary Trading?
Money management involves the various techniques traders use to limit the exposure of their trading capital. Ultimately, the goal is to profit the most while allocating the least funds.
Given the many variables at play in the markets, having a high predictive ability in binary options is hard to maintain. However, the main variable within their control is how much money traders decide to commit. With an effective, skillful strategy that puts the odds in their favor, traders have a chance to survive and thrive.
Proper money management should always focus on minimizing losses first. The same concept is crucial once traders show steady profits to ensure they don’t lose most or all their gains quickly.
Money management also applies to how traders handle their floating losses and gains during live positions. While binary options have fixed dual outcomes, various features exist during the actual trading that can enlarge said losses and gains (e.g., the ‘doubling up’ feature).
We often use the terms money management and risk management interchangeably. Despite the similarities, there is a difference. Money management refers to controlling the monetary terms of your trades (e.g., your position size or how much you stake as a percentage of your account). Meanwhile, risk is more about the techniques to limit your monetary exposure and manage different trading outcomes.
Our money management calculator can help you stay on top of your finances and avoid financial harm.
Rules For Money Management in Binary Options
Understanding the rules for proper management strategies provides the foundation for the strategies. Let’s cover them below.
Using Discretionary Income
Money management begins well before traders get busy on the charts: at the source of your trading capital. Among the most important rules in trading and investing is “only invest money you can afford to lose.” Traded markets like binary options are highly speculative and volatile. Statistically, only a few remain profitable over the long run.
The first cause is that traders use their last penny to invest in the hopes of doubling their investment quickly. The problem is the emotional attachment to this money, leading to over-trading and over-leveraging. Making better trading decisions with funds not tied to life expenses is easier.
This is why entering binary trading with discretionary income is crucial, preferably allocating a small portion of it.
Moderate Allocation
This concept relates to the common percent rule (more on this later). It’s easy for traders to risk an excessive amount of their account balance (say 10%) for each position. Yet, this increases the chances of them losing a significant portion that can be hard to recover.
For example, a trader would need an 11.1% gain to return to their previous point if they lost 10%. The recovery gain percentage increases exponentially the higher the risk.
We should also note that standard binary options naturally have low payouts, increasing the recovery rate. In a nutshell, traders should be moderate in how much they risk for every position.
Linked to moderate allocation is maintaining consistent growth. Slow and steady wins the race. While some of the strategies that will soon follow go against this principle, it’s safer to increase your position sizes bit by bit without drastic variance.
Realistic Growth Expectations
As mentioned, standard binary options provide poor returns on a per-trade despite the notion of quick profits. Thus, it’s crucial to have realistic expectations in mind.
On the bright side, there are better-paying binary options. Yet, these are more complex and hard to predict consistently. A way to deal with this problem is to speculate in profitable trading styles like general spot trading in various markets.
Strategies For Money Management
With the rules out of the way, let’s now cover the different money management strategies in more detail.
The Percent Rule
The ‘percent rule’ states traders should expose X% of their account balance for each trade. Normally, the figure is 1%. So, someone with $1,000 should not risk more than $10. While quite conservative or moderate, it accounts for the worst-case scenario. The idea is that even after an unlikely 99-trade losing streak, a trader still has money in their balance.
The percent rule is effective for a few reasons. Firstly, it’s mathematically objective and undeviating. A pitfall many traders face with money management is not maintaining consistent risk. Someone may risk 2% of their account and then, after a string of profits, increase this to 10%. It’s only a matter of time before they return to where they were before and perhaps lose more. This isn’t to say that traders cannot increase their per-trade allocation. However, this should happen gradually without an abnormally large jump.
Another benefit of the percent rule is how it steadily grows or shrinks your account. In the growth phase, the same 1% becomes more valuable over time. For instance, if you grow your equity from $1000 to $1200, your risk is $12, not the original $10.
Conversely, the same 1% decreases your per-trade allocation during a losing series. For example, if your account decreases from $1000 to $800, the risk decreases from $10 to $8.
Doubling up
‘Doubling up’ allows traders to double the payout of a profitable position. It’s a feature provided by certain binary options brokers, with traders typically being able to add it five to ten minutes before expiry.
Traders receive twice their payout if their position meets the conditions of their initial options contract. For example, assume you risked $20 to make $18 on a standard binary options trade. Adding the doubling-up feature means you can potentially net $36. Yet, doubling up is a two-edged sword since one can lose twice their stake if the conditions aren’t met. In this case, you would forfeit $40 instead of $20.
Ultimately, applying this feature to confident trading signals is best once one has several gainful positions to compensate for the potential losses.
Martingale
Martingale is the riskiest money management strategy in any traded asset. It involves doubling your bets after each loss in the hopes of a forthcoming position compensating substantially for all your losses, giving you a net profit.
For example, after losing $20, a trader would double this figure to $40, $80, $120, etc. until a winning position occurs. Yet, Martingale can lead to substantial losses even after a few unprofitable positions. This problem is further augmented in regular binary options with payouts that are less than 2x of your bet. Thus, traders would need to more than double their stake each time.
Yet, there are other variations of Martingale, often referred to as ‘reverse’ or anti-Martingale. Speculators will halve their bet sizes after each loss and double them after each gain. For instance, after losing $10, a trader allocates $5 for the next bet, $2.50 for the next one, and so on during a loss streak.
Anti-Martingale, in such scenarios, does reduce one’s financial risk. Yet, the downside is that the recovery in returning to an account’s previous peak is much slower. Once a trader begins to enter a winning streak, they will capitalize on the growth by increasing their risk twofold. Still, as with traditional Martingale, one can lose a decent chunk of their balance. By halving the bet again, the recovery process becomes slower.
While there are Anti-Martingale calculators, this strategy doesn’t stick to the principle of consistent risk mentioned earlier. One is vulnerable to losing a lot of money quickly. Determining when a winning or losing streak will happen and for how long is impossible.
Fibonacci
Fibonacci is a versatile concept in binary options for observing retracements. It borrows some elements from Martingale in the context of money management, making it similarly risky. Binary options first consider the Fibonacci sequence for this strategy, which goes as follows: 1,1,2,3,5,8,13,21,34, 55, 89, and so on.
The idea is to place larger bets during a losing streak and smaller ones during a winning streak. Traders move a step right of the sequence for each losing bet and a step to the left for every winning trade
It begins with picking a relevant number in the series as a multiplier of your bet. So, for example, choosing 1 (the first in the sequence) may represent $10. Let’s assume one went through a five-trade losing streak, with the sixth being profitable:
- $10 loss
- $10 loss
- $20 loss
- $30 loss
- $50 loss
The sixth position would necessitate a $80 bet. After a profitable outcome, the trader would revert to two places, risking $30 for the next trade (and continuing the process).
Kelly Criterion
Finally, we have the Kelly Criterion (also referred to as the Kelly strategy, Kelly formula, or Kelly bet), a less popular money management strategy. Despite this, it’s a conservative method for deciding what to allocate on a trade as a percentage. The criterion is a mathematical formula credited to John Kelly, an American scientist who lived in the 60s.
While having its roots in gambling, it applies to binary options and other forms of traded markets. It’s worth noting that this system is suitable when one knows the long-term hard numbers of their strategies, like the win rate or probability of winning.
Here is the formula:
f = p – (1-p) / (b-1)
F = the percentage or fraction that should be allocated
p = probability of winning
b = the payout
Assume you have $1000 as your account balance, and your binary options broker pays 90% or 0.9 (b) of your bet. Let’s also imagine your win rate (p) is 60%. With these figures, you would input:
0.9 – (0.6 – 0.4) / (0.9 – 1) = 2.9%
Thus, a trader would risk 2.9% of their account for that particular binary position.
(Risk warning: Your capital can be at risk)
Conclusion
They say one can succeed in binary options and other traded markets merely with a coin flip. What separates the profitable traders from the unprofitable ones in this regard is their money management. Speculators have power over this variable, a key to long-term success in binary trading. Yet, choosing the best strategies to prevent substantial losses is necessary.
Although ‘playing defence’ should be one’s priority, finding ways to steadily increase your profit potential is key to a truly gainful experience.
Most asked questions about money management in binary options trading:
How much should binary options traders risk per trade?
This depends on a trader’s risk tolerance, skill level, and experience. Yet, experts recommend not exceeding 1% of your equity as the safest option.
What is the best money management strategy in binary options?
No universally agreed best money management strategy exists. It boils down to what works the most effectively for each individual.
Can you really make money with binary options?
Yes, it’s possible, albeit only a few can achieve this goal due to the highly speculative nature of this trading style and its inherently poor payouts.
What is the most common mistake traders make with money management in binary options?
One of the most common mistakes traders make is risking too much of their account balance on a single trade. This can lead to significant losses that are hard to recover from, especially in the volatile environment of binary options trading. Sticking to a disciplined money management strategy, such as only risking a small percentage of your account per trade, is key to long-term success.
