Everybody knows that financial markets are very volatile and unpredictable. Nevertheless, many beginning traders lose their deposits in a chase for a big win. Instead of wining, they lose because they do not follow basic rules of risk management. Blinded by a promise of huge wins, they do not even think about risk management and their risk per trade can be 10%, 20% or even 30% of the account balance. They do not know that even the most experienced traders never exceed 2% exposure otherwise you risk blowing up your account. Accept 2% rule as a golden rule of risk management in trading binary options.
Binary options, just like any other form of financial trading, has an element of risk involved. You could lose all or most of your money in an instant if you are careless or greedy. As such, the concept of risk management is one that every binary options trader should take very seriously.
The generally accepted risk management rule adopted universally by professional traders is that no more than 2% of the account size should be exposed to the market at any given point in time. What this simply means, is that if you have a $1000 binary options account, you should not have more than $20 in the market at any given time. Trading anything more than this is extremely risky, especially as binary options is an “all or none” type of market.
Binary options are different from forex where traders can cut their losses early if they see a bad trade. In binary options, unless your broker is gives back 15% of invested capital in trades, or you have the opportunity to sell off the contract before expiry (variable options), then your risks are too high, and you are out of luck.
Calculating your risk in binary options is actually very easy with 2% rule which tells that you can expose only 2% of your capital at any single time. So, your first step is to identify and sign up with a broker that will allow you to place trades within the confines of your acceptable risk appetite.
Binary options brokers have made this very easy, because the moment a trader pushes the button to purchase a contract, the trader is immediately shown the cost of purchasing that contract. He cannot lose more than what he spent purchasing the binary options contract, so for every contract purchased, the amount at risk is known and the potential reward is also known. This enables the trader to do what is necessary in order to keep his risk within acceptable limits.
The essence of all this is to protect your account from the devastating effects of losses in a single trade where too much capital was invested. Imagine a situation where a trader with a $5,000 account tries to hit a $2,000 payout and invests $1000 into a trade. If that trade is out of the money, then he has lost 20% of his account in just one trade!
You may think this is over the top, but you will be surprised at how often many retail traders succumb to the destructive emotion of greed and try to dare the market in this manner. Do not fall prey to this. Traders all hope to win but the truth is that there are successful and unsuccessful trades. It has happened to everyone; even the great Warren Buffett lost millions in October 2008.
Before you start trading calculate your deposit amount based on the minimum investment required by a particular broker. If a broker’s minimum investment is 5$, your deposit should be 250$ because 5$ is exactly 2% of your deposit. This way you will be risking 2% of your account balance in each trade and you will be able to invest at least 50 times while testing your strategy. This method is smart and relatively safe.
Experienced traders recommend maintaining the risk per trade ratio at 2%. It means that you can afford to risk only 2% of the funds remaining on your account in a single trade.
It is difficult to overestimate the relevance of 2% rule in trading binary options. After buying a contract, you initially know both the potential profit and the possible loss. Therefore, using 2% of the deposit in each trade, you will have 50 trades some of which will be successful. There is a huge difference between 2% and 10%. When allocating 2% of the capital to a single deal loses might reach only 10% of the initial capital. With 10% at stake in every deal, loses may be over 40% after a series of only 5 unsuccessful deals.
Binary options trading is not a casino game or a jackpot chase. In reality, trading has nothing to do with gambling. The sooner you understand this the better. If you find yourself thinking about trading in terms of blind luck you are definitely doing something wrong. Risk management rules are here to bail you out and make your entire trading journey more productive. Remember that as a trader, you are not looking for a jackpot. Instead, you should be interested in a series of small wins, each of them getting you closer and closer to your goal. Fund allocation is not the only risk management rule to follow. Still, it is something to familiarize yourself with and, most importantly, use in your daily trading routine. Just following this simple rule can dramatically increase your chances of improvement.