Risk Management Trading Strategies for Binary Options
Risk is the potential that a chosen action or activity (including the choice of inaction) will lead to a loss (an undesirable outcome). The notion implies that a choice having an influence on the outcome exists (or existed). Potential losses themselves may also be called “risks”. Almost any investment endeavor carries some risk, but some are much more risky than others.
Whereas Management is the identification of the strategies capable of maximizing an investors net present value, the allocation of scarce capital resources, and the implementation and monitoring of a particular strategy and minimizing losses.
In the world of high finance there are many ways to limit or use risk management to reduce or prevent loss. There are hedging strategies and stop losses. There are exit points and trading systems to such as straddles that are designed to limit loss while maximizing profits. These all work well when you are dealing in asset ownership, such as stocks and bonds, commodities and currencies. They even work great with option contracts, but they do not apply in the new and fast paced world of binary option investments.
When you are trading binary option, you are actually “renting” as asset for a small space of time, in the hopes that that asset will move in the direction you have determined, either up or a call or down or a put. Trading binary option is a simplified form of investing, with minimum risk and high reward.
When you take out the complexity and risk and the actual cost of ownership from an asset, you also change the tools and methods that a trader needs to apply to handle risk management.
Since, binary option themselves as simpler so are the risk management tools. They are easy to understand, and easy to apply.
With the reduced risk of trading binary options, many brokers and trading platforms, offer little in the way of risk management. While others like iOption believe that regardless of the risk and the reward ratio, which a good investor needs all the tools to minimize losses. Each time you reduce your possible loss, give a trader a long lifecycle to reach the successful trades.
All too many traders, especially forex traders, lose their initial investment before actually learning and understanding the markets and leave, never to return. Other’s do not follow the 8% rule, which states that you should never invest more than 8% of your funds at one time, if you believe that you have a 60% chance of making profits, you need to have enough funds to suffer the losses before the profits come. You can never predict in which order profitable and non profitable trades will come. No one ever has 100% success. If you are a good trader and reach the 60% level, and use risk management tools, to limit your losses on the negative trades you net profits will grow along with your account balance.
The question begs to be asked, just how does an investor accomplish this?
Few trading platforms offer many risk management tools, the two most important are called Rollover and Buy Me Out. Their names are even simple, they describe themselves.
Rollover is a great tool and I know a lot of traders who have turned losing trades into hugely profitable ones but simply using the Rollover feature on the iOption platform.
A trader always has to keep in mind that they are “renting” an asset for a period of time, when trading binary options; it is not like a stock that you simply own and can hold on to as long as you want. You can only make profit during the “rental” period (expiry time) at the end of this period, if the asset has moved in your favor, you are “in the money” and earn profit, if the asset has moved against you, you are “out of the money” and have lost your investment. But nothing more.
Regardless how careful you analyze the markets, whether you apply fundamental analysis (this is the use of news and economic indicators such as GDP and unemployment) or technical indicators, (this is the use of charts, patterns and calculations) or you simply apply your own skills and knowledge to make an investment, there is no guarantee that the markets will move in the direction you are projecting, in the time frame in which you have “rented” that asset for.
To give you an example, when ever Federal Reserve Chairman Ben Bernanke speaks, the markets react, he can play them like a puppet master, so you have decided that in today’s’ speech that Mr. Bernanke is going to talk about monetary easing, which will affect gold and the US dollar. You have determined that Mr. Bernanke’s address will send gold soaring, so you invest 100.00 in gold, which is pay 75% and his speech is scheduled for 1330GMT, so you decide that the markets will move upwards in the period after he begins his speech, and therefore chose to enter the market at 13:00 and pick an expiry of 13:45 thus giving the markets time to react to Mr. Bernanke’s talk.
There are some introductory comments before Mr. Bernanke’s speech and then he begins his address discussing other matters, and you realize that he will not reach to his comments on monetary policy until the end of his speech which could be after your 13:45 expiry time.
You can simply enter your account on iOption and find the open trade and click on the “Rollover” icon and for a small percentage your trade will be extended to the next expiry period.
You have now prevented your loss, and turned your trade into profits as Mr. Bernanke did as you expected and gold skyrocketed. So you did not earn as much as you expected, but you still earned over 60% and you stopped a complete loss.
This is what risk management is all about, minimizing losses or turning losing trades into profits.
The next question that begs to be asked and answered is what happens if the markets do not do as I expected or they move against me?
As discussed earlier, no investor, no matter how good, how experienced or how lucky can hope to accomplish a success ratio much higher than 70% most good trades settle with a 60% profit to loss ratio. Every trader therefore experienced losses, once you can accept the idea of losses, and get past the fact that you are losing money, and deal with the inevitable you will quickly learn that you need losses in order to make profits. When you realize this and learn to factor in losses to your trades, you will learn that the loss is not significant it is the amount of the loss that is important. A good trader always learns to accept the fact that no all trades will move in their favor, so they learn to minimize or reduce their losses and not dwell on the fact that the markets are not doing what you analyzed or expected.
Buy Me Out is a great feature available from iOption; it allows a trader, to sell their position at almost any time during the “rental” period for a reduced value. When trading binary options, there are basically only two possible scenarios, you are either “in the money” (you made profits) or “out of the money” and you lose your investment.
It is basically an all or nothing scenario. Now, if I could offer you a tool that would change that from an all or not nothing scenario won’t you exercise this and stop your “nothing” or “out of the money” possibility.
When the markets are not moving in your favor, you can simply click on the “Buy Me Out” button on the trade on the floating chart screen “Buy Back Your Trade” of course this is not free and you still suffer a loss, but you reduce your loss. Let’s use the Ben Bernanke example again.
You have entered your trade for gold, saying that Mr. Bernanke was going to drive the markets up. When Mr. Bernanke begins to speak you realize that his speech today is going to be more concentrated on “shadow banks” and not on economics or monetary policy.
At this point you have an investment of 100.00, the markets are fluctuating but gold is below where you need it to be to make profits, or be in the money and you realizing that it will most likely stay there for the time being.
You can exercise the “Buy Me Out” feature on the platform and they will offer to close your trade for 45.00 (this number is hypothetical as there are a long series of calculations that take place when you click the “Buy Me Out” button. But in the end what this means, is that you take a loss of 45.00 instead of losing your entire investment of 100.00 and you minimize your losses.
In my world, this is a successful outcome; you have turned a loss of 100.00 into a loss of 45.00. This is the true definition of risk management and the sign of good traders.
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Barry produces a private Daily Market Review newsletter that is distributed around the globe to over 25,000 subscribers and recently published a book on Options Trading that is available from amazon.comView all of FX Empire Analyst - Barry Norman's Articles