Strategies to Manage Investment Risk
With every binary options trade that you place, there is an element of risk. That is the nature of binary options trading and indeed any investments that you make. There are no guarantees, and there is as much chance of winning as there is of losing. It's learning how to manage and minimise the risk that is the key to your success.
By exercising good risk management, you can reduce the losses and maximise the profits or try and offset your losses. Risk management is not just about being cautious or fearing the potential losses. It is about giving you the confidence to be more strategic and to consider how to effectively manage the risks that you take each time you trade.
This guide covers risk which is inherent in every trade, including binary options trades. Risk management is the best strategy to reduce the chance of experiencing significant losses.
The one-per cent rule is a simple risk management strategy; you stick to trading 1% of your account balance to minimise the chance of significant losses.
Another risk management guide to consider is the 5/15 rule. You restrict yourself to trading 5%of your account balance in a single trade or 15% across multiple transactions.
Finally, the diversifying hedge rule involves investing in two assets simultaneously, such as two different currency pairs like EUR/USD and USD/EUR, so you make a profit whatever happens.
What is Risk Management
When predicting the outcome of the price of an asset, there is an equal chance of winning or losing. You are betting on a result that you can't control. Yes, you can research historical data, trends and use trading tools to help you identify patterns and predict the future of prices but how do you minimise the risk if it does all go wrong?
How can you foresee a global event or major company news or announcements and change your strategy? The answer is that you can't prevent these things, but you can learn to spot the threats and learn how to minimise the impact on your trading. Removing the emotion is the right place to start, but it's not just about being cautious.
There are many strategies and techniques that traders can use to reduce the impact of a series of losing trades on the balance of your account. It is about being smarter and following in applying these learnings to your activity. As a result of other people's losses, you can implement some basic rules and strategies to improve your own experience and make your balance go much further.
The One-Percent Rule
If you are unsure as to how much you should be investing in each trade then following the one percent rule is an excellent place to start. Typically, the advice is never to risk more than 5% of the account balance on a trade. If the account balance is $5,000, then this equates to $250. Lose that money, and your balance will start to go down quite quickly.
A more popular strategy is to spend 1% of your account balance. In this instance, each trade will equate to $50. With 100 trades available rather than 25, your money will go much further.
Using the one percent rule means that you will keep your losses shallow when these losses start to escalate, psychology begins to play a part, emotion takes over, and you can risk a disastrous outcome that very quickly leaves you with nothing. If you have a bad trading day when the markets are volatile, or everything is against you, you are limiting the damage to your account balance.
Following this rule mitigates the risk of encountering massive losses and can help you to feel a great deal more relaxed about trading.
The 5/15 Rule
This rule refers to a trading session as a whole. You can choose to invest 5% of your account balance in a single trade or 15% across a multiple of trades. Let's look at how this works. Let's say you have $10,000 in your account. Now 5% of this is $500 and 15% is $1,500. The trick is not to spend more than these amounts in any one session.
You can place 3 trades at $500 a go, or you can use $1,500 in one single big trade. You can use this rule to diversify your investments. While there are those that will advise that you stick to one asset, there are others who will advocate this trading strategy as a great way to test other assets.
Diversifying the trades means that you spread the risk while trying new things and increasing both your portfolio and experience. If you decide to split the $1,500 into smaller amounts, you can use one for your existing asset of choice, one on a commodity and one on a stock as an example. This way the exposure is never more than 15% in any single session.
If you are unsure as to how much you should be investing in each trade, then the one percent rule is a good start.
The Diversifying/Hedge Rule
Diversifying means to reduce the volatility of your portfolio by placing trades on various assets while hedging reduces the loss by predicting the outcome of another complimentary product. Let's take currency pairs for example. The USD/JPY and the JPY/USD. Now by placing a trade on both, you win either way. Sure, you don't earn as much as if you stick with one outcome, but you do win something.
If one of your pairs finishes against what you predicted, you know the other one is going to end with a correct outcome. Following this rule is not going to make you rich quick, but it is going to stop you from losing all of your money. Diversifying and hedging your activity is particularly useful when the markets are volatile.
Perhaps there is going to a big announcement that has left the market a bit shaky and people aren't quite sure how things are going to go. Maybe there has been a global event which has left the markets a little shaky. The diversifying/hedging rule should not get used all of the time, but it can be used to exercise effective risk management.
Shelly is proud of her current position as Head of Brand for a well-known organisation that owns several brokerages in the trading sector. She’s consulted for us since 2015 and readers can benefit from her insider knowledge of how brokers work.