When it comes to trading financial investments you will find countless articles written about trading strategies. In fact researching strategies probably occupies nearly 99% of the traders time. Forums are full of people deliberating over the market they should be trading, the indicators they should use, the best time of day to trade.
However did you realise that when it comes to trading, money management is one of the most important elements of your strategy? When it comes to trading with Binary Options, money management strategies are particularly important. This is due to the ‘all or nothing’ nature of the trading.
So if you want to succeed with your binary trading you need to look at your current strategy and make sure it is set to maximize your potential for building profits.
Money Management And Risk
Money management and risk are two interlinked terms when it comes to financial trading. While there are differences between the two terms, essentially the way in which you manage your trading capital will also help determine the amount of risk that you take with it. Therefore it is hard to use one term without referencing the other.
When setting out a plan for your trading you will want to minimize your risks. This will include not only the strategy you use (in terms of markets traded, contract length etc) but also the level of capital which you place on each outcome.
While it can be tempting to place the entire amount of your trading capital on the outcome of one contract, the chances are that if you follow this path, you will sooner or later come unstuck. This is of course a very uncomfortable feeling when you have to come to terms with the fact that you have blown your entire account. This will of course quickly end your trading career.
Money Management Strategies
There are a number of approaches that you can use to set up an efficient binary options money management strategy for your trading. Once of the simplest and most effective is known as the ‘Kelly’ system, so named after its creator. If you like long mathematical equations you can read more about it here - Kelly System
This strategy has now become something of an accepted mainstream investment theory and is an ideal method on which to found your own binary options money management strategy.
The concept behind this method aims to achieve maximum growth while also minimizing associated risk. To put it simply, the greatest limitation to producing good returns comes from the risks associated with losing. Therefore if you can minimize these risks, you will have a much better chance of making profits on your account going forward.
The Kelly System For Binary Options
The Kelly system is actually very easy to implement. While to the letter of the system you should only use 1/19th of your available capital of any one outcome, it tends to be easier to use 1/20th.
This equates to 5% of your trading capital which should only ever be exposed on any single contract.
So how would this work in practice?
Let’s take a look at the example below:
Starting capital $1000 dollars. So 1/20th (5%) would equal an optimum size of $50 per binary contract placed in your account.
With a typical binary options broker this would equate to 5% risked for a potential 3.5% return, assuming a 70% pay out. (Any rebates are not taken into account here).
While this may seem low to some binary traders, remember that this approach focuses on risk reduction and capital generation in order to maximize long term growth potential.
It is also important to understand that by following this approach you can take a ‘hit’ on your account and survive a string of losses. In fact you would be able to withstand a run of twenty losing trades before your account balance hit zero. Of course if this was the case then it is probably time to review your strategy…
Final Thoughts
There is a fine line between gambling and trading. Employing effective money management in binary options will seek to maximize the trading element. To ‘gamble’ is to take a high risk with limited chance of reaching our expected pay out. To ‘trade’ is to take a calculated risk that will still give you a good return and importantly, keep you in the game for the long term.
Not only will following such an approach actually help you to improve your results, it will also help your mental well being. When undertaking any form of trading you should never be in a position where you are sweating on a contract winning.
Setting out and sticking to a strategy which provides effective money management for binary options trading will not only make sure you are not kept awake at night; it will also ensure that a loss won’t signal the end of your trading career.