Any type of financial investing involves risk. Risk management is all about how one can reduce the risk that is present using tools and strategies. Eliminating risk is simply not possible. Read on to find out about the basic risk management strategies used in binary options trading.
The two major aspects involved in risk management in binary options trading is much like any other investment format that is chosen: financial and behavioral/psychological.
As regards the financial aspects, the basic aim is to conserve the money, choose safer options, turn a losing trade into a winning one, and how to secure profits. The factors that influence these would be the size of the option, the bankroll, asset class and the actual underlying asset, market conditions and hedging.
#1: Investment Amount/Bankroll
The money invested in a binary options trade should be an amount that the trader is willing to lose. If not, the money should be clearly parked in a bank account or in the form of a more conservative investment. The trader should also be careful not to invest all of the extra money into binary options investments. It is a sure fact that some money will always be lost in binary options trades. Everything that the trader has should not be risked into this one option.
Controlling the investment in binary options contracts also helps to control the risk that the trader is exposed to. However, in this case, the profits also come in slowly than otherwise. If you are more comfortable with long-term investments, it is recommended that you stay that way and do not invest into binary options contracts which have very short expiration times. It is better to be ‘slow’ in the beginning.
#2: Have Some Basic Knowledge
It is strongly recommended that a novice binary options trader develops some basic knowledge prior to investing his/her hard-earned money. In binary options, there are four asset classes that a trader can invest in. They are: commodities, indices, currencies and, of course, stocks. For a beginner, it is the safest to invest in stocks (assuming the trader has sufficient knowledge in that class) until the learning about the asset classes is complete. It is important for the trader to be able to to analyze the markets appropriately before indulging in a trade because one company may do well when another one in the same asset class is performing poorly. It is also important for the novice trader to realize that all asset classes are actually interrelated in the complex economy of the world.
#3: Pay attention To Details
If traders want to manage risk effectively it is important that they are sensitive to information around them. Quick processing of information about the different asset classes that is available to them can translate into sound investments and less loss.
#4: Have a Sound Plan in Advance
In the financial world, it is important to anticipate news that can help the trader to control the risk. This also helps the trader to plan ahead and steer clear of or minimize the losses.
Hedging in binary options allow the trader to cut the risks involved. Typically, the trader buys a second option (in the opposite direction of the first one) when it is nearing the end of the expiration period of the first trade. This action places the trader in an advantageous position, whatever is the outcome for the first trade. If both end in the money, the advantage is big. If the first trade ends out of the money, the amount of money lost is small or may help the trader to break even.
From a behavioral point of view, the question is whether the trader still considers the whole activity of trading binary options as a form of gambling or as an investment. Psychological aspects also include the ability of traders to maintain their emotional levels even when the going is good or bad, apply the brakes to reduce the risk on when trading happens at high speeds, and develop a sense of professionalism.
It is, therefore, important that the trader evaluates his/her self to perform better: whether your emotional makeup defines you as an angry, impulsive or calm person; are you a risk-taker or not and if so to what extent; are you patient enough to study market conditions or are you in a hurry to reap the returns; are you an innate gambler, etc., are some of the questions for which the trader has to find out answers for.
#1: Evaluating the Basic Psychology
Trading in binary options is not akin to playing the roulette. This is because in the latter case the play is driven only by pure excitement. Trading in binary options, on the other hand, requires a careful and patient study of the underlying asset class and the market conditions before placing the trade.
Additionally, the trader remains calm in the face of any outcome, whether positive or negative. In case the trader wins, he/she must resist any temptation to invest further and quickly win more returns. Today’s favorable conditions may not remain tomorrow. In case the trader loses, it is equally important for him/her to resist the temptation to make good the losses by investing more money into trades. It is important to learn and take the right corrective measures.
#2: Be Smart
All the trades should not be placed based on a single decision. This is because wrong decisions can be made by just about anybody.
Summarizing, risk management is indeed one of the most difficult topics to be learned and implemented. Too many factors influence risk management. It is essential to apply the risk management tools appropriately and use common sense. For the daredevil traders, it is important to realize that to be able to invest in future, learning and applying risk management principles are important. If losing trades angers the trader more than necessary and does not allow calmness to settle down, it is important that he/she seeks professional advice to get rid of the problem.