Risk management and the 5% club
For all new traders, the choice of what, where and how to trade is absolutely outstanding. The internet has not only broken down the mythical image of trading as an exclusive activity, but it has also changed the way that individual traders can interact with endless markets on a 24 hour basis. Over the past ten years trading stocks, forex, spread betting and binary options have become available to everyone with an internet connection and a computer. With this explosion in popularity, a whole host of brokers and platforms have arrived along with websites dedicated to traders’ needs, forums, software and a wealth of literature for novices to learn how to make money from the comfort of their own home.Trading binary options, for example, no longer requires a big bank account and a Wall Street office. Within two minutes an account can be opened by anyone residing in a jurisdiction which allows online speculation and options can be purchased with the click of a mouse. Alongside the sheer simplicity of placing a trade, the brokers, software developers, support websites, strategists and analysts all thrive of the growing popularity of online trading. Popular advertising tells new traders that they can make hundreds or even thousands of US Dollars per month and hundreds of thousands of new traders join the market with this in mind.The thing that most of those with an interest in selling their products to new traders fail to explain is that approximately 95% of new traders will fail to make any money trading.The underlying reason why such a small percentage of new traders are able to be successful trading anything is because they have a thorough understanding of the risks of trading before throwing their money at the market. Whilst it is easy for any new trader to understand that all speculation is littered with the risk of losses, it is the 95% of new traders who consistently fail to act on this information. Risk management is therefore not just a theory or something to only implement occasionally, it is a membership card to a small club of successful binary options traders who use this to stay ahead of the other 95% who are consistently unprofitable.
What does risk management involve?
Risk management varies from trader to trader, depending on the individual circumstances and type of trading being undertaken. However, it also has several features which are central to all binary options traders. The first thing to acknowledge is the obvious fact that all financial speculation carries the risk of losses. If everyone made substantial amounts of risk-free money, the markets would not only cease to exist, but nobody would bother going to work. Risk is therefore essential to the markets and the management of this is central to the success of any trader.
Why it is so difficult for new traders to be profitable
One of the key difficulties for all new traders, and one of the principal reasons why many only ever flirt with the 5% club occasionally is that most unsuccessful traders will tend to focus only on profits. This is clearly not difficult when brokers, platforms, books and tipsters are throwing arbitrary profit figures in order to encourage new traders to sign-up or purchase their trading guides. Profits are attractive and losses are not, which is precisely why many brokers will not provide the extensive risk management education necessary to support new traders to become successful and profitable over time. New traders therefore begin full of confidence and enthusiasm which soon begins to fade once their capital reduces rather than steadily increasing. Instead of focusing on profits, if risk management is the starting point for all new traders, then many more will be successful in the long term.
Start with risk and watch the profits develop
Starting with risk management may sound like the boring option for everyone eager to begin to make money trading but it is the only way to ensure long-term trading success. The reason why so many traders fail is because they fail to address their risk, trade impulsively and without a plan and eventually deplete their account. Before looking a how to practically apply successful risk management it is important to look at the ways in which risk management can be applied to improve the potential for profitable returns.Regardless of the strategy or method of investing that a trader chooses; by protecting the capital that they already have will substantially improve their chances of success. Failure to incorporate the basics of risk management will turn a trading account in to a gaming account within no time at all. Below are several basic tenets to trading and then we can see how these can apply specifically to trading binary options:
- Limit the first depositMany platforms require new traders to make a deposit in order to begin trading and often these are small relative to the amount of capital that a trader has put aside to trade. The temptation for many is to fill up their account with all their funds and begin trading immediately. However, as with all new ventures, proper risk management would encourage a trader to only part with a small portion of their funds within one account initially and in order not to risk any problems with the platform or broker. It makes a lot of sense to test the services that you will be provided with a minimum deposit before transferring larger amounts in order to both avoid becoming stuck with a poor broker and to avoid any potential of a being scammed out of having your deposit returned.
- Trade in proportion to your account regardless of the potentialRisk management is centered on preserving capital and the only way that this can be done is to limit the exposure of a trading account to losses. This is known as trading in proportion and it is an essential discipline which all successful traders have mastered. It involves deciding on a safe percentage of the account that a trader is willing to risk on any single trading position. Typically, professional traders risk no more than 2% on each position which allows them to endure multiple losses without depleting their account. For many new traders, this seems like a tiny and pointless amount but there are ways in which small trades of 2% can be very effective of a short amount of time. The temptation for traders to increase their exposure on trades that seem like a ‘no-brainer’, or dead certainty, is one of the mistakes made by all traders at some point. Since there is no such thing as certainty in trading it is essential for all new traders to manage their risk equally through all trades in any trading strategy. Not only does allowing the discretion to apply rules subjectively reduce the essential discipline of traders, but it also disturbs the monitoring of steady account growth. Many successful traders point out that removing emotion and trading mechanically is the secret to success. Risk management of stake size should not be an exception and proportionally small trades should be placed robotically and equally regardless of the potential success of the setup.
- Using stop losses and leaving them aloneStop losses can be used by forex, spread betting and stock traders to limit the risk to a trading account. Placing a stop loss order in the market will close the trade when losses hit a certain threshold. This will signal that the trade has either failed or the financial risk is becoming too great for the account. Due to the fact that markets can reduce to zero and fly higher without limit means that without stop losses an entire trading account, and more, is potentially at risk. Stop losses are an excellent way to manage risk but they also need to be used properly. Many traders will place their stops at technical or ‘fail points’ where they are triggered if the trading decision is proven to be wrong. It is essential for successful risk management, however, that these levels are not altered during the course of the trade. The temptation to increase stop losses, and thus to increase financial losses, in the hope that the trade will eventually turn good is one of the easiest ways to deplete a trading account. Stop losses can also be used to ‘trail’ profits in order to prevent a positive trade suddenly turning negative and to help manage the success of a trade.
- Resisting the desire to over tradeStarting to trade is exciting and all traders are at risk of trading, or wanting to trade, too much. This happens to everyone and both patience and discipline are required so that only those setups or strategies with the highest probability of success are traded. Continuously wanting to be involved in any market has its pitfalls including the potential for multiple losses. Many trading gurus point out that new trader’s should start by trading larger timeframes, such as the hourly or daily, to help limit trading before taking these acquired skills to the shorter intra-day timeframes including 5 minute charts and below. Opportunities occur on all timeframes and waiting for the optimum trade will both increase success and reduce the risks involved.
- Holding positions overnightModern internet trading allows traders to make money 24 hours per day on a huge range of markets. However, this can be both potentially rewarding and equally damaging as these are difficult to monitor around the clock. Holding short-term positions during regular sleeping hours can expose new traders to unforeseen risk and shocks which may occur on the other side of the world. Particularly sensitive to this are commodities and currencies which operate on a 24 hour basis and which are highly sensitive to global news and data. Stocks are equally vulnerable to volatility for traders who hold positions overnight in anticipation of a continuation of a profitable session the following day. Being aware that holding short-term positions can be exposed to these risks and using stop losses to prevent over-exposure are important risk management strategies for these trades.
- Find a broker and platform that suits your tradingWhilst many trading platforms offer similar products, they can and do vary in their suitability to the risk exposure of individual traders. From the markets available to trade to spreads, bonus conditions, contract expiry times, charting software, support and trade limits, platforms differ in what they offer their clients. It is important to begin small with any platform in order to mitigate the risk that it may not be entirely suitable for an individual trader. Thorough research prior to parting with any real money, and ideally the use of a demo account, will help to reduce the risk of any problems. Similarly, talking to other traders who use a platform can be particularly helpful in getting feedback on the experiences of others.
Binary options risk management
Risk management of all financial investments has a similar basis as has been outlined in the basic tenets above. However, binary options risk management is distinct in several ways which can benefit new or inexperienced traders looking to speculate on financial markets. We will look at these below in order to show how risk management can be practically applied to all binary options traders:
- Limiting the first deposit in binary optionsAlmost all platforms will allow traders to limit their exposure by allowing a relatively low first deposit to be applied to new accounts. However, it is worth noting that some platforms offering bonuses with new deposits will require the trader to deposit larger subsequent amounts in order to be able to withdraw account funds. This has been seen as a problem with some platforms such as BancDeBinary and new traders are advised to make sure that they read the terms and conditions carefully before accepting such an offer. bot.192.168.1.143.xip.io, however, maintains both a low initial deposit and allows withdrawals to all traders without such complications and which makes it an excellent broker for those wanting to start trading binary options with lower risk.
- Trading binary options in proportion to your account regardless of the potentialBinary options have the unique benefit of providing the trader with precisely how much he or she is set to gain or lose before the options are purchased. One the transaction is executed these levels cannot be altered and therefore the trader knows exactly the level of exposure that an account will be exposed to in cases where options close out-of-the-money. By taking on board the basic risk management strategy of limiting an account to just 2% of the value of that account, binary options traders can benefit from strict control over their trades and develop in to profitable traders. Furthermore, for those who think that 2% is too little, it is worth remembering that using this strategy will compound an account as it grows. An example of this is an account growing at, say, 1.5% for each successful trade then the subsequent risk of the next trade will also grow in financial terms whilst maintaining a 2% risk threshold. This can be explained with the example of a $1000 account with a $20 risk threshold which, over time, will grow in to a $2000 account with a risk threshold of $40 and an increasing profit value relative to this.
- Using stop losses and leaving them aloneAnother great attribute that binary options have over other forms of financial speculation is that a stop loss is not necessary. This is particularly helpful for new traders who are already aware of the maximum risk that they can expose their accounts before purchasing any options. There is also no possibility to extend the stop loss and therefore the position cannot close out early for this reason. One of the distinct advantages of this is that a binary option can potentially close profitably and stress on traders is greatly reduced without market volatility increasing losses. SOM platforms also allow positions to be ‘rolled over’ or alternatively ‘closed early’ for a lower profit which can increase the chances of being consistently profitable.
- Resisting the desire to overtrade and holding positions overnightUnfortunately, the same risk management is required for binary options traders in terms of limiting the temptation to overtrade. Binary options can be purchased with expiries of just sixty seconds so there are literally 86,400 opportunities to trade each day. Learning to be selective is the most effective way to limit risk and sticking to a tested strategy is also key to continued trading success. One benefit, however, of binary options in terms of holding positions overnight is that this is not a temptation if the expiry does not allow this. Although the same risks would apply to positions held overnight for any investment, binary options expiries can be set to close within just a matter of hours of minutes or hours to limit the temptation to hold these overnight. Additionally, because they do not rely on the degree of the price movements (only if it is higher or lower than the strike price), a sudden overnight rise or fall would not extend the losses already predetermined before the options were purchased.
- Find a broker and platform that suits your tradingA suitable platform and broker are essential to binary options risk management. As already noted, some of these may not necessarily be operating in trader’s best interests and it is important to choose the one which will best suit individual styles of trading. Whether it is sixty second trading, range, touch or longer term options that are most appealing, finding a platform which can offer these is a good start to a long-term relationship. Furthermore, those platforms which offer little in the way of educational support and information will be those least suitable for any new trader. Binary options risk management will be hugely improved if the platform provides warnings and advice in regards to limiting financial exposure, especially to new traders.
Risk management is absolutely ssential for the success of all traders, regardless of the form of speculation being undertaken. All professionals, with track-records of success, will have risk management strategies in place (however basic) to prevent losses which may threaten their ability to trade. There are several basic risk management tenets which all new traders should focus on before jumping in to the markets expecting to be profitable. If these are observed the probability of becoming a successful and profitable trader increases exponentially. Among all forms of speculation and investment, binary options offers some distinct advantages to new and inexperienced traders in regards to risk management. The transparency and foresight of potential losses which binary options provide to all traders allow binary options risk to be managed highly effectively relative to other forms of trading.