Risk Management

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Binary Options Risk Management:
Many traders consider Options trading to be a high-risk and high-reward strategy, because in each trade it is possible to make profits that are multiples of the original investment. It is also possible to lose the entire investment. For that reason, risk management is critical to a successful trading strategy. There are several key elements to a risk management strategy: Allocating your capital appropriately to the strategy, diversification and trade size, and choosing appropriate trades.

Allocating Capital:
First and foremost, when allocating capital to a binary options trading strategy, you want to make sure you can afford to lose some of your capital. Many experienced traders will tell you that the first rule of trading is don’t lose money. While that is great advice, in practice it is impossible to make money without taking risk and it is impossible to take risk without losing money sometimes. Binary options is a probability game, and even if your trading strategy is advantaged you still may lose money on some trades. Example: You allocate $50,000 to a trading strategy, but you can really only afford to lose $5,000. A few large unexpected losses early on could wipe out your $5,000 and take you out of the trading game. For that reason, you should not put money that you cannot afford to lose towards this strategy because you don’t want losses in your first few trades to take you out of the game. A better strategy is to allocate only the $5,000 that you can afford to lose. Having a capital cushion where you can afford to lose some of your capital means your portfolio can withstand a few small losses early in the game. Over time as you grow your trading book with gains you can take larger positions.

Diversification:
Remember the proverb, “don’t put all your eggs in one basket.” Instead, spread out your risk through diversification. This means you will do several (or many) smaller trades rather than one or just a few large trades. There is no magic answer as to the right number of trades; it is about finding the sweet spot. If you have 100 positions at once, you will have a lot of diversity but you may struggle to manage trading them each day. Something like 20 is a good number to start with. Assuming you trade 10 hours per day, this means you will do approximately 2 trades each hour, which feels manageable. A loss will only impact 5% of your portfolio. Of course, if your strategy requires many hours of research for each trade, 20 trades per day may be too many. Again, there is no magic number that works for everyone. As far as which trades you select, you should also try to diversify your trades as much as possible within the confines of your trading strategy. For example, if your strategy focuses on binary options on currency pairs, you want to trade a variety of pairs. Trading different pairs means that if there is news on one country that adversely affects your trade, it will only impact one of your positions (not all of them). If your strategy focuses only on AUD/USD, for example, it is harder to diversify but you can still choose options with different strike prices and expiration times to spread out your risk.

Try to stagger your expirations by entering positions at different times during the day and select options that expire at different times during the day. This way, if there is global news impacting all of your pairs at a specific time, you will not have too many positions expiring at once.

Trade Selection:
Choose appropriate trades that minimize risk and maximize profit. This is a balance that each trader needs to find for his or her strategy. In order to make profits you need to take risk. It is about finding trades that have appropriate levels of profit potential to compensate you for the risk you are taking.
Risk management is one of the most important elements of a successful trading strategy. If you get this part right, you will avoid unnecessary losses and trade smarter.

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