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§2.2 Risk management in options trading

Управление рисками при торговле бинарными опционами

Before we discuss trading strategies that help to win trades I would like to talk about risks and balance management. It has been said above that binary options are attractive due to the fact that you can know exactly what sum of money do you risk because the sum is your option’s value. However you run the risk of losing, not only the investment amount of the option but also some part of your deposit. Here some questions arise: what is the correct risk management method and how to place “bets” properly so that you don’t lose everything and keep positive dynamics going in total?

The first thing you need to understand well is that you can’t win in every trade. You will lose in 40%, 30%, 20% of cases which depends on your trading system and experience. Both novice and very advanced traders lose, and that’s OK, because it is impossible to predict the market fully. The main difference is that losses incurred by experienced traders of binary options do not prevent them from moving forward and earning. While beginners give up on all of their previous achievements and quit after losing once.

How can one prevent it?
Управление рисками при торговле бинарными опционами
Suppose you have 100$ on your account. Therefore, this is a maximum value of the option available for you. However, you can’t buy the option for 100$, of course, because in case of failure you will lose all your money at once and have to replenish your balance again. 50 dollars will be a critical loss too, because if you lose it, it will be very difficult for you to recoup and in general you should remember that the less money you have on your balance, the harder for you to make a certain amount of money. For example, if you have 100$ deposit you can easily make a profit of 25$ in 1 or 2 trades. But if you have 10 trades then it is difficult to earn the same $ 25. That’s why; sophisticated traders adhere to the following principles:

  • The principle of progressive enhancement of capabilities which follows from the previous idea. Earning little by little is very helpful to increase your balance each time. If you make 200$ on 100$, then withdraw 70-80$ from your deposit it will leave you with 120$ on your balance. IF you make 300$ on the 100$ then leave 180$ on your balance. Thus, every time you will increase the amount of money you can win in one trade without much risk. But if you make a trade, you will need to evaluate and analyze everything equally, regardless of whether you want to win one dollar or one thousand dollars. To make fewer trades and to pay more attention to each trade is worth the effort to increase your balance.
  • The principle of surplus. To put it simply, if you win one trade and lose another one, you should be in the black. You can do so if the estimated profit from a trade is greater than potential losses. For example, if you won 65$ and lost 50$ then your balance will increase. If, however, your ratio is -10$, you will still stay at the same level if you win and lose even 10 transactions. Well, when the ratio is negative, it will be almost impossible for you to win in the long run.
  • The principle of minimizing risks.
  • The principle of minimizing risks. There are different views on what percentage of your deposit can be lost at one time. However, the maximum recommendation is 10%. If you are just starting out and not confident in your abilities then it is worth lowering this amount to 3-5%. If you have 100$ on your balance, you can buy options for 3-5$ if you’re a cautious trader or for 7-10$ if you’re a more experienced and aggressive trader. However, it is unacceptable to run the risk of larger sum of money, even according to the most aggressive traders, because there is a very high risk of losing everything at once.

A good options trader is not someone who can win million dollars in one trade. The ability to increase one’s initial deposit after two or three months of trading is considered to be an attribute of skilled traders. This kind of trading enables to earn a steady income on trading options and make this occupation a truly profitable business for you.

§3 Basic principles of creating trading strategies →