What are your rules for regulating your risk-exposure when you trade binary options?
Editors note: This article first assumes that you have done your research and are working with a legitimate binary options broker. This can be especially difficult for American binary traders as there are multiple offshore choices but limited USA based brokers (see more).
5 Trading Factors That Impact Your Risk
There is an element of risk every single time you place a trade; there is no such thing as a sure winner in any market. No matter how superlative the setup, there is a chance that the trade will fail.
It is easy to take an overly simplistic view of risk—say to define it as synonymous with your stake for example.
There really are two main ways you can define risk. One is the probability of winning vs. losing. The other is the amount you could stand to lose.
There are a number of factors which modify risk in either respect, and you should think about all of them before you place a binary options trade.
Trading Factor 1. The size of the position.
As I just mentioned, your stake accounts for your risk in large part—this is how you calculate the amount of money you could win or lose. With binary options, the math is quite simple. You check the payout percentage and multiply it by your stake to find out what you could win. In terms of how much you can lose, that depends on whether your broker offers out-of-money refunds or not.
If not, the amount of your stake is also the amount you could lose. If however there is an out-of-money refund, it will usually be 10%, but might be some higher percentage. Multiply it by your stake and then subtract it from the original amount of your stake to find out what your risk is.
So if you are wagering $100 on a trade and the payout percentage is 75% and the out-of-money refund is 10%, you could win $75 or you could lose $90.
There are a lot of different ways you can try to control your sizing to reduce your risk. The best method is to use a percentage of your account and keep it consistent. I see traders wagering all kinds of crazy stakes, sometimes putting down 10% or more on a trade. I recommend keeping it down to 2.5%. Look for brokers with small minimum trade sizes if your bankroll does not allow larger traders.
So if your total account is $1,000, stake $25.
2. Correlations between the positions you take.
Do you place multiple trades simultaneously? If so, have you considered that you may actually be stacking up correlated risk exposure? Imagine for example you have several “High” trades in related assets. Even though these appear to be independent trades, they are not entirely, because they rely on the same real-world factors going your way. If you lose one, you are likely to lose the others. So if you risk $25 on each, in a way, you are risking $75 on a single underlying wager about the direction and movement of the markets.
This does not necessarily mean you should avoid this kind of situation every time, but make sure you think about what you are doing and have strong rules in place regulating multiple trades.
3. How volatile the market conditions are.
Market conditions are never constant. Sometimes they are smooth and quiet, other times they trend nicely up or down, and still other times they are choppy, volatile, and unpredictable.
You are always facing more risk in a volatile, choppy market. Your stake may be identical, but your probability of losing a trade is higher.
There are other more predictable factors which can make the market volatile as well. Coming back from weekends you will typically see some strange spikes. You can expect the same over holidays as well as during world events. There is generally going to be some chop whenever a financial report is released.
Avoiding trading during these times (unless you have a system that requires it) will usually be a smart move to reduce your risk exposure.
4. What timeframe you are trading.
Do you take trades which typically close in a few hours or days? Long-term trades which are open for weeks or months? Or do you opt for “turbo” trades which close in five minutes or less?
If you take short-term trades—those which are five minutes or less—you are presumably planning your trades using charts which display a very short timeframe (if you are not planning at all, that is a much bigger problem).
These charts have limitations; because less data goes into forming each of the bars, each of them tells you less than the bars at higher timeframes. Since a lot more data goes into forming a daily bar than a one-minute bar, obviously that daily bar will tell you more about what the market is doing. It is more solid.
This does not mean you should avoid short-term trades; you may do very well at them. Just know going in that the risk is higher because the market is choppier at this level. Beginners who underestimate this can lose a lot of money.
5. The quality and location of the trade setup.
The last factor which determines your risk exposure is the quality of your system and the setup and context for each individual trade.
In fact, you could argue that is the definition of a system. It is a set of rules designed to limit your risk by maximizing the probability that you will win your trades.
If you have a system which you have tested and proven works, you are on track to keeping your risk under control.
As I said earlier, there is no way to be 100% sure that any given trade will win; even a really amazing setup can fail.
But the statistical likelihood is low, given that the system works. So when you are getting ready to make a trade, carefully analyze the setup and make sure that it is well formed and that it is contextually well-placed. This will keep your risk to a minimum.
Mitigating Risk Is the Secret to Trading Success
Now you can see why risk is much more complex than simply your stake size. Your stake is part of the equation, but not all of it. So consider all of these factors when you weigh the probability of winning any given binary options trade and when you consider how much you have to lose. Once you minimize your risk and do so consistently, you will be on your way to profits.