Binary options are a simple form of trading that involves certain loss or failure. You risk a certain amount of money for a specified period based on a prediction. The financial instrument you’re betting on with a binary broker like https://www.binaryoptions.com/broker/deriv/ always goes up or down in price. So, you’ll have to make a correct prediction in order to increase your capital.
Many traders who try to choose between forex and binary options pick the latter. This is because binary options are much simpler and result in an affixed proportion of win or loss. However, even though trading binary options entices most traders, it still carries the same risk as the forex market.
Risk is the probability of your prediction being wrong, triggering a loss of a part of your trading capital. Every trade you make comes with a different risk level, depending on several factors. These factors include the market you select, the pair you’re choosing, and the size of the trade.
Understanding Risk Management
Simply put, risk management refers to the steps a trader needs to take before and after a trade to ensure that the loss is under control. It is not uncommon to hear that some people lose huge amounts of money while trading. This loss is caused by not following proper risk management measures.
Risk management has to be learned right from the moment you decide to delve into trading. Whether you are a trader who risks money in the markets for fun, a trader who works in a hedge fund, or a trader who relies on trading profits to survive, you need this form of financial management.
A good risk management plan will allow you to average potential profits or losses on trades. That way, you will be able to determine whether you should make the trade or not.
Even though different traders have different risk management plans, certain factors are common to forms of strategies. First, your risk management plan has to allow you to consider all the possible outcomes.
Second, your risk management must be so solid that it can be followed at all times. If you’ve ever heard the saying that ‘traders don’t have emotions,’ it is because of financial management. When you perform risk analysis before carrying out a trade, you are more likely to cut out the emotions from trading.
Third, efficient financial management has to encourage portfolio diversification. When trading binary options, you have to examine the price movement of different currency pairs or assets you want to trade.
Your risk analysis plan also has to include the regulation of brokers. This way, you wouldn’t be denied access to any profit you make. The last part of risk management has to do with following your mind, and not your heart.
Most times, when many people follow a trend, traders become pressured to follow suit. However, when you carefully analyze situations where traders were in a frenzy to rush into a decision, you’ll notice that they often have a negative outcome.
From the Great Depression, the 2008 Financial Recession, the dot-com boom, and even recent Bitcoin price crashes, investors who rushed to a market have hardly panned out well. You must carefully analyze whether an asset or currency is worth buying when traders follow a trend. If you feel the asset is overbought or oversold, you can decide to move on to other assets or currency pairs.
Top Binary Options Risk Management Strategies
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Risking the Right Amount
More experienced traders understand that the minimum required trade size varies between brokers. When you consider this in your risk management plan, you should calculate the minimum amount you deposit.
The idea is to never risk more than 5% of your account at any given time, even if the trade prediction is certain to come true. For instance, if your broker requires a minimum of $5 for every trade, you need to deposit at least $100. $5 is 5% of $100. This allows you to meet the maximum risk amount for a trade.
In contrast, imagine a trader who deposits $50 in a brokerage platform where the minimum trade size is $5. This means that the trader would have to risk at least 10% of the trading capital on every trade. If the first two trades end in a loss, that’s 20% of the entire trading capital gone, and a situation like this would put most traders into a panic mode.
Panicking is one of the leading causes of bad decisions in the trading space, so you’ll have to do what you can to avoid it. If you strictly adhere to your risk management plan, you’ll be more than unlikely to make mistakes like these.
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Perfecting your Trading Psychology
For most individuals, when finances are involved, a loss or gain would lead to heightened emotions. Since all of us need money to survive, it’s only logical that it plays such a vital role in every individual’s life. When traders happen to lose money on a trade, they usually want to attempt to restore their trading accounts to their previous state as soon as possible.
One of the ways traders try to do this is by increasing the amount of money they place on their next trade. The idea is that when the trade ends up in a profit, the loss will be wiped off. Nevertheless, all things considered, there’s always a 50% probability that a trade will end up in a loss.
Imagine a case where such a trader loses the new trade – this means the loss becomes unnecessarily bigger. Disorientation sets into the mind of the trader.
Perfecting trading psychology deals with reducing your trade size in the next trade after losing a previous one. A trader who can make this decision and stick to it has mastered the art of cutting out emotions from trading.
Reducing the trade size can help traders in two key ways. The first is that if the trader loses the trade, they don’t become disoriented since the loss was smaller than the previous one. The second is that if the trader happens to win the trade, they will get a boost of confidence, which will help them become more confident in future trades.
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Getting Familiar with Binary Options Trading Risks
The probability of a gain or loss in the binary options markets should be a shared 50%. However, things are a bit different in the real world. You should expect to make only about 70-90% of your capital when you win a binary options trade. On the other hand, 100% of your trading capital is gone if you happen to lose.
So, if you do the math, you’ll see that you’ll still be at a loss if you win only 50% of your trades, provided that your trade size remains constant.
Understanding this binary options risk allows you to tailor your risk management strategy to maximize profit.
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Setting a Predetermined Risk-Reward Ratio
Most serious traders have pre-determined risk-to-reward levels that allow them to aggregate profits over time. A sensible risk-reward ratio starts from 1:1.5 upward. This means that if you lose 50% of all your trades up to a certain period, you remain at 1.5 times your initial trading capital.
If you’re a trader who experiences more losses than wins, your risk-reward ratio needs to be higher to break even. It would be best to consider that 100% winning payouts aren’t experienced in binary options markets to set your risk-reward ratio accordingly.
Conclusion
The binary options market has always been easier to understand and take part in than the forex market. That’s why many new traders jump into the space and lose a lot of money. Risk management ensures that you still have a lot of money left over after experiencing a trading loss.
It also helps to limit your binary options trading losses to a particular level. The best risk management strategies are usually the ones that work on eliminating emotions. Risk management encourages portfolio diversification and gives you perfect flexibility.
Risk management steps include setting risk-reward ratios, perfecting your trading psychology, and risking the right amount of money.
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