Money management plays an essential role in any binary options trading strategy. Many professional traders cite the ability to control risk and exposure, rather than simply generating profits, as the single most influential element of their success. Many new traders, however, see the ability to make profits as a far more exciting and important aspect of trading which can lead to the neglect of basic money-management principles and, ultimately, failure as a binary options trader.
Focusing on binary options profits
Focusing on profits is a natural beginning to binary options trading. With some brokers offering in excess of 80% profits on regular binary options, and over 500% on touch and range trading, it is fairly obvious that there is a fairly large incentive to begin trading binary options. However, the major problem with this focus on the profits involved in binary option, which are substantial, is the fact that losses can also be incurred as with any form of financial speculation.
With losses on binary options being incurred at between 85-100% of the initial investment it becomes clear that a large portion of trading capital can easily be wiped out with one unlucky, and over-leveraged purchase. The basics of money management, in order to avoid the classic trap of placing too much of your trading account on one “guaranteed trade” is to predetermine the level of risk that the account, rather than the trader, is prepared to incur. Typically, the golden rule here is a 2% risk of available trading capital although this may be a very small amount for each trade. The logic behind this is not only to protect the majority of fund in a binary options account but also, as the account grows with successful trading, this 2% also increases. This provides not only a steady growth in the size of each trade and also the value of the account without increasing the risk.
Prepare for trades that may fail
Another money management strategy which many traders employ when trading binary options is to plan for the “worst case scenario”. Binary options traders have the advantage over regular traders in that they do not incur losses by the degree that price moves away from the strike price. This is either ‘in or out of the money’. This can be used to the advantage of many traders who find a losing position suddenly heading back towards a close in the money. Absolutely hopeless positions, however, can also be salvaged using the brokers ‘close early’ feature. This allows the options to be closed out at a loss lower than the predetermined loss before their expiry. Whilst still a losing trade, incurring losses at or less than the profit attainable (typically 80%) will help to give a trader a long-term risk-to-reward level of at least 1:1.
Neutralising risk in volatile markets
On occasions, markets swing wildly back and forth in a directionless mess which can be unattractive for binary options traders. When this occurs whilst a trader still holds a position, pushing the options in and out of the money, it can be not only highly stressful but increasingly risky. One way to combat these conditions is to hedge a position as close as possible to the original strike price. A hedge acts as a purchase of options in the opposite direction to the original position. If it is placed at the original strike price for the same value, one set of options will close in and the other out of the money. Whilst this may seem like a pointless exercise, it can be used at times of market indirection and volatility to neutralise any profits (typically 80%) and limit losses (often 85%) resulting in just a 5% loss. For many, this is preferable than the ‘gamble’ of hoping that the original options expire in the money.