Managing Risk, Losses, and Hedging Your Binary Trades

Whenever you deal with any type of financial trade, you need to understand not only how to make money – which is usually the purpose of getting involved with financial trading after all – but also learn about the best ways to manage losses. With binary trading, it is even more important to know about managing losses.This is because of the all or nothing nature of binary options. If you buy a binary option for $100 and it doesn’t expire in the money, then you have lost your $100 investment. In contrast, if you are investing in stocks and shares, and buy something at $100, even if the price drops you can still sell for $90 if you’re able to sell fairly early and do not want to hang onto something and wait for a potential recovery. Very rarely in other types of trading will you lose 100% of your investment if things go wrong. When you are binary option trading, however, it is a way of life. Managing risk successfully will put you in a position to make profits as often as possible, and means that you won’t regularly find yourself adopting your binary options strategy to account for losses and problems.The key phrase in all of this is “managing risk.” That is all you can do with it. There is no such thing as a risk free trading strategy that always guarantees a return. If there was, then everyone would be following it and everyone would be very well off!

Defining Risk

Before knowing your limits, you need to be clear on what the risk is; if you don’t know what you’re managing, how can you manage it? In terms of financial trading, we define risk as the probability of an unsuccessful result. Therefore, with binary trading, the risk is the likelihood that your option will expire out of the money, meaning you lose 100% of your investment. You are probably familiar with the term “riskeward.” This is a very important consideration to make when formulating a binary options strategy. Initially, a risk might appear to be one that is not worth taking. However, if the potential returns from a high-risk trade are better than they normally would be – some binary option trades can have returns of up to 500%, which would be a good example – then you might consider an increased level of risk to be acceptable. With most types of financial trading, the biggest returns from single trades usually come from those with the highest risk. Consider this when formulating binary options trading strategies. The most sensible approach is normally to take on lower risk for lower yet more assured rewards (remember, there are no guarantees), but you could always place a speculative trade from the profits you made from your regular strategy. Your approach to binary options trading will depend on your financial situation. Be prepared to adapt and evolve this should your finances change.

Determining Your Personal Strategy

The difference between binary option trading and other types of trade should also be considered. The biggest thing to keep in mind at all times is that if your binary option expires out of the money, you lose your whole investment. If you take out a high-risk investment elsewhere, you may lose money but you could also simply receive your initial capital back. Binary trading offers no such variables; you get the money or you don’t.If you are new to binary trading, a good approach to take is to look at your trades as a percentage of what you have. For example, if you are starting with a bank of $10,000, you might decide that 1% is the maximum you will stake on each trade, meaning $100 is your standard trade investment, which is a common minimum for binary trading platforms anyway. It is generally considered that anything at 5% or above is high-risk. Experienced traders will usually invest at 1 – 3% of their bank. Trading such sums means that you are not putting large percentages of your bank at risk.Remember that this is only one part of your binary options trading strategy. Determining how much you invest per trade is one element of the risk; you then need to look at the charts and determine whether the risk is worth it considering the market you are taking out a binary option on.

Buy Low, Sell High

Anyone who has shown any interest in trading of any kind will be aware of this mantra. Because you buy a binary option as an all or nothing trade, however, you should allow for further movement in the market. For example, say you are trading a particular commodity when the price is high. If you bought low, and the price continues to increase after selling, you might be annoyed at yourself but at least you have made a profit, which was your aim starting out. Likewise, if you buy low and the price continues to drop, you can manage the loss by selling to someone else looking to buy low.When trading binary options, it is harder to take a black and white buy low and sell high approach. There is no room for manoeuvre and no profit if a price continues to rise or fall. It is best when binary trading to pull back from this and await the establishment of upward or downward trendlines before making a decision.It is also worth avoiding breakouts during your early trades; when the price is stagnant and then suddenly shoots up, as they can just as quickly fall back and leave you with a loss.

Flexible Options Brokers: Benefits

Another method for managing risk is to find a binary options broker that offers some flexibility with your trades, specifically in the form of early exits or rollovers.

  • Early exits can allow you to “cut your losses” if a trade appears to be expiring out of the money. This moves away from the all or nothing nature of binary trades as you can still receive something back rather than lose 100% of your investment.
  • Rollovers allow you to lengthen the expiry time of your binary option. Typically given when options are expiring out of the money, some brokers will also offer higher returns should you extend when an option is in the money.

Early exits, in particular, should be considered by new binary traders, as they can be effective in managing losses if you are not yet totally comfortable with reading charts or spotting trends and patterns.Some brokers will also offer “out of the money refunds,” which are typically around 15%. Although not a huge sum, it is better than losing everything, and is definitely something worth looking out for.Another strategy for managing risk yourself is to consider hedging your binary trades.

What is Hedging?

You have probably heard the phrase “hedging your bets” used in some context or other during your lifetime. Although binary trading isn’t gambling, you can benefit from hedging, only in this context you are hedging your trades.To hedge a binary option, you need to buy a call or a put option before the end of an existing trade. For example, if you buy a call option, which is currently in the money, you can then buy a put option to expire at the same time, which will lock in at least part of the profit. Remember that you can’t hedge an option that is already out of the money, as you’ll just be increasing your losses.The biggest thing to understand with hedging is that you need to spend time working out how much you need to place on each trade in order to be profitable.Here’s an example of how you might hedge a trade:Asset: GooglePUT criteria: Below $150CALL criteria: Above $160Expiry: One hourThe above is an alert that you might receive through your binary trading platform. Say you’re trading at 1pm and after receiving the alert, you notice the price falls below $150, prompting you to buy the PUT option for $100 (or whatever sum your strategy dictates). Let’s say that this trade finishing in the money gives you an 80% return. At this point, you’re either going to make 80% profit or a total loss.Just before 2pm, your put option is in the money, but Google is showing as oversold and the price is starting to rise. You can then choose to hedge your trade by taking out a CALL option that finishes at the same time as your original PUT. If you buy the CALL option, which needs to be above a price lower than the original PUT criteria, you create a small opportunity to make a double return.For example, if the price is currently $145 and you buy a call option above $147, an expiry price of $147 – $150 will see you get the 80% return on both options, a total return of $360 ($160 profit).If this doesn’t happen, you will at least get a return of $180 (maybe more if your broker offers out of the money refunds), which reduces your overall loss to $20 instead of $100, which it would have been had Google continued to rise and expired out of the money without you buying the second option.

Should You Hedge Binary Options?

Although it is difficult to be profitable with binary hedging, it can be a useful way to increase returns and importantly, to limit losses. To be consistently profitable with hedging, you need to be an experienced trader who can recognize how the markets are moving. You need to be smart with binary hedging and recognize the opportunity to make extra money. Yes, it is a strategy you can use to limit losses, but you need to have the “double return” scenario in mind at all times, otherwise you’ll be losing up to $20, based on our example, every time you hedge.Hedging is not the simple binary options trading strategy many believe it to be – many use it but endure nothing but limited losses, yet somehow think they are being successful – and you will need to spend time building your knowledge of binary trading before following such a path.

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