Money Management – Part II

October 26, 2012

This is my second post on money mangement, click here to read my first.

I have heard recommendations that investing up to 5% of one’s account balance is considered safe in binary options trading. However, I would have to disagree. In order to wipe out 25% of the account balance, all it takes is a streak of five losing trades, which is rather easy to do if you are overtrading, trading in overly volatile or spastic markets conditions, and/or simply relatively new to trading. When you encounter a losing streak with such a high risk parameter, that 5% can eventually grow into a much larger percentage of available capital. For instance, let’s say you start out with a $500 account and choose to risk 5% of that on each trade ($25). If you lose five trades in a row, you’re now down to $375. Even if you continually adjust the trade size to accord for what’s currently available in the account – i.e., you would now need to trade just $18.75 per trade – it’s going to take an even better spell of winning to even consider bringing the account back up to break-even, let alone turning a profit. In fact, you might not even be able to make a trade that small depending on the broker or type of option you’re trading (e.g., minimum trade size on 24option is $24, and $100 on the Option Builder offered by some platforms, for instace).

Moreover, if you become emotional over losing money and decide to recoup those losses by trading larger and larger sizes (e.g., a Martingale-like strategy), you will inevitably crash and burn eventually and end up with nothing. Martingale strategies have permanently ended many trading careers. You will find that many of the best traders in the world scoff at the Martingale concept and for good reason. They never turn out pretty and fundamentally restrict the maximum trade size you can make. For instance, the current maximum trade size on 24option is $20,000, but investing $1,000 per trade would be imprudent in that you wouldn’t be able to sustain more than four losses in a row before you would no longer be able to recover those losses (and be $31,000 in the hole assuming a simple double-up type of Martingale).

While it’s important to set personal rules (e.g., trade only with the trend, no more than three trades per day) and attainable short-term goals (e.g., achieve an ITM percentage of 60% or high), which may differ from those of other traders, I feel a big mistake is to set a monetary goal that must be met by a certain date or, worse yet, every single day. It is very difficult to become emotionally detached from your trading when certain profit goals are inaptly given priority. I used profit goals when I first began trading, and I found that they were nothing but a distraction. Ironically, I often didn’t attain them because I was so concerned about making X amount of money or growing the balance by a certain percentage that I became less choosy over the trades I took and lost money instead.

So what type of money management do I apply to my own trading? I actually traded small, fixed amounts – as I discussed in my first money management post – up until just recently. Now, I have shifted to an alternative, slightly more complex style where I alter my trades based on the quality of the set-up and how much capital I have available to me. The image below provides a basic, visual overview of how I go about it.

You can see in the image that I gradually scale up my investment size over the course of the trading session, which might be perceived as risky. However, even losing a higher-probability trade would set me back profit-wise only about two trades, on average. That’s an acceptable level of risk for me personally, given that I feel like I’m at a point in my trading where I can reach a regular level of good accuracy. I would never recommend this strategy to a total beginner, but the basic concept of varying trade size in accordance with the quality of the set-up is something to consider should you ever progress to a reasonable level of precision with your trading.

Trading can be a very lucrative undertaking, but it never will be if the trader can’t progress past the stage where he is greedy, impatient, and desires instant gratification. If one is looking to make a lot of money right off the bat, it isn’t going to happen. The exact opposite will. The vast majority of traders will never net-earn a single penny during their online trading careers and much of it has to do with poor money management. A trader can have the best technical analysis skills in the world and have a great knack for spotting ideal trade entries, but all that can be corrupted by a risky, unreliable, or downright non-existent money management plan.