Risk and Money Management

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Welcome to the second lesson of the Advanced Binary Options training course. In this lesson, we will teach you everything that you should know about risk and money management when it comes to binary options trading.

We already told you that money management is the most important aspect to consider if you’re trying to become a long-term profitable trader. But now, we are going to illustrate this point by going through an example where we will take two traders, starting off with $10,000 on their accounts and having the same results on 5 trades. The difference between these two traders is that Trader One sticks to a 5% rule, meaning that no matter what happens and no matter how much his balance is, he only risks 5% of his trading account on a single trade.

On the other hand, Trader Two doesn’t and he is all over the place, going bigger and chasing his losses. This is what their account links would look like. Let’s say trade one was a loss and Trader One by only risking 5% of his account, is now down $500. Trader Two decided to start bigger and risk 10% of his account, so he’s over a balance stance at $9000 and he’s down $1000 on the first trade.

Let’s say that trade number two is also a losing trade. The option expired out of the money at Trader One by risking only 5% of his outstanding balance of $9,500 is now down to $9,025. Trader Two decided to go even bigger and risk 29% of his account because he wanted to recoup the $1000 that he already lost and make profits in one single trade. So he decided to go bigger and risk 29% of his account. Sadly his option also expired out of the money and he’s down to $6390, which means that in two trades he has managed to lose almost 40% of his trading capital.

Let’s say that trade number three is a winning trade. Trader number one is a disciplined trader and he sticks to his five percent rule. So he only risks 5% of his outstanding balance of $9,025. His option expires in the money so his balance now stands at $9407. Trader number two, being completely irrational went even bigger and risked 35% of his account. His option expired in the money so his balance now stands at $8,626. But as you can see here, trader number two had to risk 35%of his remaining $6390 and his balance is lower than Trader 1’s balance.

Trade four is also a win and Trader One we already know that he is a disciplined trader so he’s almost breaking even in four trades. Trader Two decided to go a little bit lower and try a 15% risk and he is almost breaking even too. Now trade five is also a winner and by risking 5% of his account trader number one is up overall $447. Trader Two decided to risk only 10% and he is up $900 overall.

The difference between Trader One and Trader Two is that Trader One is a consistent and disciplined trader that can over stand losing streaks. Trader Two is not. Let’s say that trade number three was a loser. Trader Two would have lost 35% of his $6390 and would be down to around $4000. In three trades he would have managed to lose 60% plus of his trade capital, while trader number one would only have lost 13 to 15% if trade number there were a loser.

This is why money management is important. You need to stick to a 5% rule and you need to be disciplined with it. We also need to know where the break for an even ratio is. The break even ratio is a number of accurate trading decisions we need to make in order to break even. Because you need to know the percentage of times, your option needs to expire in the money in order to break even.

As you know the pay-on scales when trading binary options are off. This means that if you’re wrong, your trading decision is not accurate, your option will expire out of the money and you will lose 100% of your initial investment. But if your trade decision is accurate, you option will expire in the money and the broker will pay you out from 75% to 82% depending on the asset and the broker you are trading with. So the overall break even ratio formula is out-of-the-money percentage divided by in-the-money percentage plus out-of-the- money percentage.

Now let’s take an example where the payout is 82%. The break even ratio would be 100 divided by 82 plus 100 which will be 0.449 which would make our break even ratio in this particular instrument 54.9%. This means that you will need to accurately trade 54.9% of your options to break even. This is important to know because you need to have a system that will at least have 60% winners. In this course you will learn how to increase your odds to end up in the money by only picking hyper-probability trades.

Now, let’s go through all the rules we have learned here. First of all, calculate the break even ratio of the instrument you are trading. If the break even ratio is too high, if it goes above 60 it means that the payout of this instrument is too low and you must choose another instrument to trade.

Never risk more than 5% of your account on a single trade. This is the golden rule and if you are not comfortable with 5% you can go lower to 3% or maybe 2%. That is up to you. But more than 5% is just irresponsible.

Never chase your losses. Never go bigger because you have just had a losing trade. Stick with your strategies and don’t chase trades. This means that if the entry is gone, well the entry is gone and you move to the next set up. If you’re too late to take the trade you don’t take the trade because if you take the trade too late that means that your entry is not a high probability entry.

You need to follow the strategies and only take high probability trades. Only taking high probability trades will make your win-loss ratio go higher, meaning that you will be beating the break even ratio of the instrument by a much larger percent, meaning that you will make more money by only risking 5% of your account. So these words are lesson on risk and money management.

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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