You have what you believe is a great trade setting up, and you’re ready to take a position, but how much do you “bet?” Position size is something many traders don’t think about, they just take a position they think they can afford and hit the buy button. Unfortunately, determining position is a bit more complex than that, as your position size should account for the amount of capital you have and the risk you’re taking. Position sizing in trading falls under the category of money management, and should be lain out in explicit detail in your trading plan (see: In Beginners Trading Concepts: Creating a Trading Plan). Here is how to determine the exact position you size should be taking when trading binary options.
Why Position Size Matters
No matter how good your trading strategies, or how good of a trader you think you are, losing trades happen. Additionally, you don’t know on which trades you will lose. By always managing your position size, you minimize the chance of a handful of trades decimating your account.
The biggest problem for most beginner traders is taking a position that is too large for their account. Doing so puts the trader at a great risk of depleting the account so much that it becomes nearly impossible to earn it back. Other traders have more control at the beginning, betting small amounts that align with their account size, but then something changes. Once a few losses occur, they begin to “double up” or increase their position in order to make up for the losses. This is a dangerous strategy–if the string of losses continues the account may be completely wiped out.
A less common problem is not betting enough. If your trades are excessively small for the account size you have, then it is unlikely you will be able to meet your trading goals since you won’t make enough on each trade. In this case, risk is not the concern, but inability to grow capital is.
Taking the right position size is a balancing act between facing losses that are too large, and rewards that are not large enough. To get the proper balance, you must first establish your percentage-at-risk rule.
This rule determines the maximum percentage of your account you’ll risk on a single trade. To give you an idea, professional traders generally risk 1% of their account, or less, on each trade. This may seem small, but it makes sure that no single trade, or even a long string of losses, hurts the account substantially.
Risking 1% or less on a single trade can be a big challenge when trading a small account, but becomes much easier to adhere to once the account is larger. For example, if you open an account for $1000, the most you can risk $10 on each trade. If you have a $500,000 account, you can risk up to $5000 per trade, but if short-term trading you likely won’t even risk that much on each trade. Therefore, with a small account you’re at a disadvantage; but small accounts can slowly grow into bigger accounts by not taking on excessive risk. Avoid the urge to “gamble” by taking on trades that are too large for the account.
Professional traders didn’t come up with this rule after becoming professionals, they used the rule to become professionals.
If your account is too small to use the 1% rule, it is recommended you don’t trade till the account is adequately funded to trade properly. Alternatively you can increase your risk threshold, risking 2% or 3% of your account on a single trade; but this is not recommended.
Write down the maximum percentage of your account you’ll risk on a single trade, and write it in your trading plan.
Calculating Position Size
Now that you have your percentage-at-risk rule in place, you can determine your position size. Your position size will fluctuate based your account size and the riskiness of the trade. Therefore, not every trade will be the same size. Let’s look at a couple examples for determining position size with binary options.
When you make a binary options trade, you know your risk. The only thing you need to know is the maximum percentage of your account you’ll risk. If you’ve chosen to risk up to 1% of your account, and you have a $5000 account, you can buy a call/put for up to $50.
Some binary options brokers will give you back a 0% to 10% credit on your investment when you make a losing trade. The amount of the credit is provided when you make a trade, allowing you to further fine-tune your position size.
If you know you will get 10% of your investment back if you lose, you’re not actually risking the full amount you invest. You can therefore take a slightly larger position. In this case, you can make a $55 trade, knowing you’re only actually risking $49.50 [$55 – ($55 x 10%) =$ 49.50]. Your total risk is still less than 1% of the account, but you have maximised the position size.
If the amount of capital in your account declines, this will reduce your position size. If the account grows, you will be able to take larger positions.
Money management is arguably the most important aspect of trading, and one of the biggest factors in managing your money is position sizing. Try to risk less than 1% of account on a trade; read books by, or interviews with, professional traders and this rule (or something similar) is a common theme. If you have a small account, choose a broker that allows you trade in small increments; you’ll be able to stick to your money management rules and trade positions sizes that align with your account size. By using proper position sizing you dramatically decrease the risk of rapidly depleting your account due to a string of losses. At the same time, if you are utilizing a high win ratio strategy, you’ll be able to slowly grow your account and hopefully meet your trading goals.