Money management is a vital element of trading. When applied to a high risk, high return form of investing such as binary options, it becomes even more important. Here, we explain the basic concept of money management, before expanding on the subject further, and exploring wider money strategy.
Basics Of Money Management
Money management and risk control are key for successful trading. When I say key what I mean is that money management, as a form of risk control, is how you protect yourself from yourself, how you eliminate (to the extent you can) fear and greed, how you ensure you never wipe yourself out of the market and can always come back to trade again.
It is the process of managing your total investing capital. Most people will understand that risking the entire sum in one trade is a bad idea. Likewise, many people will understand why ‘portfolio’ management includes allocation and diversification elements. Similar principles apply when managing a binary options bankroll.
Beyond those more obvious benefits however, are the ways it provides more subtle help for traders. The ability to make decisions with more clarity, the security of knowing there will be money to trade with in future and the knowledge that growth will lead to further growth without any increased risk or planning.
There are many ways to do it. Money management – true money management – is a method to control risk while allowing you the freedom to trade, and for profitable positions to make as much money as they can.
The most widely used method of money management is called the Percent Rule:
The Percent Rule says that each and every trade is always X% of your account. Cautious traders may go as low as 1%. Riskier traders may go as high as 5%, but regardless the amount it is always the same. There are a couple of reasons why this system works so well, and why so many traders like to use it.
- It takes the guesswork out of trade size and is crucial in terms of trading psychology. There is never a question of how much should this trade be or letting your emotions make decisions for you. A fearful trader may make a trade that is too small even when the signal is really good, an overly confident trader may make trades that are too big, even when the signals aren’t great. This method leaves your mind free and clear to focus on what is really important, the signals and how to trade them.
- Using a percent rather than a set amount means that the size of your trade will grow, or shrink, with your account. This means that if you have a losing streak you will make successive smaller trades. No one trade ever large enough to wipe you out and no losing streak so bad it will wipe you out either. On the flipside, as your account grows so to will the % you trade so that your profits will grow too. An amount like 5% may seem small when you are trading $20 to make $36 but it’s no different than trading $2000 to make $3600, if that is what 5% of your account is.
- The Percent Rule doesn’t so much boost confidence as removes an obstacle that may shake what confidence you already have. At the same time it keeps your account safe long enough to gain some experience, and by extension the confidence that comes with achieving a goal. When it comes to trading, confidence is what pays the bills, anyone can spot a signal but only a confident trader will trade it and be able to walk away without spilling a tear if it loses.
This is how it works. If your first deposit is $500 then a 5% trade size is $25. To keep things simple I would trade $25 until the account was $550, then the trade size ups to $27.5. If you lose then the account falls to $475 and you reduce your trade size. In this case that would be $23.75, if your broker doesn’t let you enter pennies into the trade amount then I would round down rather than up to err on the safe side.
When it comes to adjusting your trade size it is just as important to raise it as it is to lower it, you don’t want to cut yourself out of profits you should have made by trading only trading 3% or 4% of your account when you should have been trading 5%.
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 higher), 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 wrongly taking priority. I used profit goals when I first began trading, and I found that they were nothing but a distraction that led me to make bad trading decisions and losses I could have avoided.
Calculating your risk in binary options is actually very easy. With the 5% rule, for every $1000 in your account you can afford to expose $50 at any single time. This means all trades are $50 until you begin to win or lose and have to make an adjustment. So, after reading this your first step is to identify and sign up with a broker that will allow you to place trades within the confines of your acceptable risk appetite.
The calculation needs to be based on your appetite for risk too. A 5% plan is fine, but is probably still at the higher end of the risk scale. A 1% per trade strategy will reduce risk even further. This might be helpful for those just starting out in binary options. As noted above however, the minimum trade size available with your broker, may dictate the smallest percentage you can trade with.