Here at The Binary Options Experts, we talk rather a lot about risk management, but what exactly does it mean? Allow me to explain…
Like all forms of financial trading, trading binary options has an element of risk. It is possible to lose some or all of your money very quickly, particularly if you are emotional and succumb to greed or revenge trading. Therefore risk management is something you should take very seriously, and have in place before you begin to trade.
Most professional traders adopt the rule that no more than 5% of your account size should be in the market at any given time. For beginner traders, especially those with a smaller account, we advise no more than 1% risk. This is where all the hours you have put in on developing a trader’s mindset will come into play.
So, if you have an account of $1000 and you are an experienced trader, you will have a maximum of $50 in the market at any one point in time.
Remember, patience and compounding are how you will grow your account to bigger profits, not over-trading.
In short, binary options are an “all or nothing” type of market. Unlike forex, where you can cut your losses early if you see that your trade is going bad, with binary options, you lose it all if your trade goes bad. (Unless your platform/broker gives you back a percentage of your invested capital in losing trades, or you are able to sell off the contract before expiry).
So you can see that you need to properly utilize the only means of controlling risk available to you. How do you do this?
It’s actually quite simple.
If you have $1000 in your trading account, we have already identified that you can only afford to expose $50 at any single time. So you need to find a platform that allows you to place trades within your defined risk parameters. It’s very easy to work out, as you are shown the cost of your trade before you place it. This is what makes binary options so attractive – you cannot lose more than you invest, and the risk and reward is known before you enter the market.
This means you can easily manage your risk and keep your losses within acceptable limits.
The above image is what might be a typical trade for a $1,000 account. The expected payout for this Rise/Fall trade is $90.
As you can see, payouts are made up of both capital and profit. So for a payout of $90, this trade will cost either $51.37 or $49.69, which is approximately 5% (acceptable risk) of the account size.
Remember though that this is for one trade only. If you decide to take two trades, then you need to split your payout, and your risk, into two.
The reason for this is to protect your trading account from the blow of enormous losses in a single trade. Imagine if you had a $5,000 account and decided to attempt a $2,000 payout. That is an investment of $1000 into one single trade. If that trade is a loss, you have just lost 20% of your account – in as little as 15 minutes!
You might think this is ridiculous, but this is what happens without a plan – plenty of traders get into the greed mindset and will attempt to “win back” their losses. Don’t be one of them.
There will always be times when you make bad trade calls. It happens to everyone – even Warren Buffett lost millions in October 2008. At the end of the day though, what separates those who bounce back from their losses, is their ability to control risk.