Binary options, just like any other form of financial trading, has an element of risk involved. You could lose all or most of your money in an instant if you are careless or greedy. As such, the concept of risk management is one that every binary options trader should take very seriously.
The generally accepted risk management rule adopted universally by professional traders is that no more than 20% of the account funds should be exposed to the market at any given point in time. What this simply means, is that if you have a $10000 binary options account, you should not have more than $2000 in the market at any given time. Trading anything more than this is extremely risky, especially as binary options is an “all or none” type of market.
It is not like forex where you can cut your losses early if you see that you are probably in a bad trade. In binary options if your trade goes bad you may lose the initial funds ( (unless you have the opportunity to sell off the contract before expiry). So you need to be sure that you properly utilize the only means of controlling risk available to you.
Calculating your risk in binary options is actually very easy. For every $10000 in your account, you can only afford to expose $2000 at any single time.
The moment a trader pushes the button to purchase a contract, the trader is immediately shown the cost of purchasing that contract. You cannot lose more than what you spent purchasing the binary options contract, so for every contract purchased, the amount at risk is known and the potential reward is also known. This enables the trader to do what is necessary in order to keep his risk within acceptable limits.
This is a typical trade for a $10000 account. The expected payout for the Rise/Fall trade is $500. In binary options, payouts are made up of your invested capital and your profit. So for a payout of $500, this trade will cost the trader either $267.67 or $268.70, which is approximately 2.5% of the account size.
The essence of all this is to protect your account from the bad effects of losses in a single trade where too much capital was invested. Imagine a situation where a trader with a $10,000 account tries to hit a $8,000 payout and invests $4000 into a trade. If that trade is out of the money, then he has lost 40% of his account in just ONE trade!
You may think this is over the top but you will be surprised at how often many traders succumb to the destructive emotion of greed and try to dare the market in this manner. So please plan wisely.
We all hope to win but the truth is that there will be times when we make bad trade calls. It has happened to everyone; even the great Warren Buffett lost millions in October 2008. But what separates those who re-emerge as successful traders from the rest is the ability to control their risk. Control yours too.