When trading, as in any activity that involves risk, you need to have a clear and coherent money management plan. Without it, you would be trying to build a house without first laying the foundation. Many traders miss this important aspect of trading as there are more things to consider than just counting your money. Then it is just as important as working out a plan for it; discipline is the golden rule here.
Drawing up a coherent plan starts by asking yourself the following 3 questions;
- How much do I want to risk in general?
- How much do I want to risk per day?
- How much can I risk per trade?
Risk Management Trading Systems
It can be quite easy to answer the first question. For example, I have £5000 and I want to test my trading skills, this is the amount I can afford to risk. But from the £5000 you start with, you can limit your maximum loss to £2500, which is reasonable. If your trading only results in losses and you find yourself losing 50% of your capital, it is probably best to stop. Take a step back and try to determine what is going wrong. At this point, it appears that there is something wrong with your trading plan and it needs to be reconsidered.
The second question is a little more difficult and takes a little more thought. How often do you think about trading? Given the example above, how quickly are you willing to risk £2500 before you have to stop? My feeling is that you should not risk burning out your capital in less than 2 to 4 weeks, which means 10 to 20 trading days. So you should think about 1/10 to 1/20 of your capital per day. This means you would be risking between £250 and £125 per day.
Are you an ‘active’ trader?
This assumes that you will be actively trading, or at least once a day. What if you only want to trade from time to time? Maybe on the back of an idea you had, or a recent news headline. Suppose you trade possibly every 2 or 3 days. In this case, it can be very tempting to think that you can add up the cash you didn’t risk on the days you didn’t trade. So “I haven’t traded for two days, I can risk £750 or £375 on one trade today”. In fact, it increases the risk you are taking, and you could be down £2250 with just three bad trades. Yes, it may still take two weeks to pick up this loss, but it only took you three wrong trades, and it can happen very easily. In this case it is also best to stick to 1/10th or 1/20th per trade day or something closer to 1/20 if it all goes on one trade.
This leads us to answer the final question, how much risk per trade is acceptable? It depends on how many times you want to trade a day and whether you are willing to spend a lot of time in front of your screen. It may be that you only have enough time to place 1 trade per day, in which case I would recommend that your single trade (and daily risk) totals 1/20 of your risk capital in the above case £125.
Let’s say you have decided to trade £200 a day with binary options and you intend to trade every day. You can put it all on one trade and see if you were successful. This would end up being the riskiest route. It depends on how much time you can spend trading, but I would split the daily number you decided between 2 to 4 trades. You don’t necessarily have to make them all, but it’s better to give yourself a few chances a day, not just one. If you have the time, splitting the daily risk size into different trades can be more rewarding.
Brokers with a low minimum trade size
Apply money management to binary options
The thing I like best about trading Binary Options is that risk is well under control. You know how much your maximum risk per trade is when you place it, and that is simply the cost of the option. However, human emotions can also come into play, especially on a bad day. As we saw above, if you lose your daily risk amount, you basically have to turn off your screen and wait for tomorrow.
This is probably the most difficult task to follow. As a trader, you will feel that you can get it right; just try one more time. But we have to look at it this way, let’s say you have a daily risk limit of £210, which you divide into 3 trades of £70 each. If you happen to get all three wrong, you probably won’t get the fourth right either, simply because of fatigue or trading based on emotion.
At this point you may be upset or out of emotional balance, this may lead to bad judgment and you are likely to choose another losing trade. From a monetary point of view you are down £210 and placing a new trade will give you the chance to back at best 90% or £63 which will not make you a profit for the day, But if you lose the trade, you will now be down another £70 for a total loss of £280 for the day.
It can only feel worse, and more dangerous can start a very risky spiral where you no longer have limits on how much you can lose in a day or in total. Limits are a great way to encourage discipline in trading.
You can also add more rules or limits. Taking the above example (£210 daily limit split into 3 trades), you can add the line; 2 straight losses and I’m done. For example, say you start the day with 3 straight wins, no reason to stop on a streak. But now let’s say you lose the next two.
Now you still have profit for the day and can walk away. This rule, of two losses and more, will protect your profits for the day and limit the loss, not only what you have earned, but also your daily risk limit. If you continue to trade, you may make two more winning trades, but you may make two more losing trades, in which case, if you are up £210 for the day, you find yourself down £70 for the day. The rule ‘2 straight losing trades = out’ can help protect your profits. Remember that one of the most important concepts is capital preservation and being able to trade again tomorrow.
Rules like these may suit some investors and not others, but the three fundamental questions remain. One thing every broker can agree on is that money management is crucial when it comes to trading success.
Percentage rule
Another popular money management strategy is to risk only a certain percentage of the total investment fund. One of the advantages of this system is that the size of the trade grows after a series of trades, and is also scaled back in case of losses.
The percentage rule represents a very simple system. On any single trade, only a certain percentage of the fund is at risk. It will rarely be more than 5%. A sustainable strategy with low risk is possible only 1% of the total funds.
The rule is not strict because the percentage does not need to be calculated before each trade – just regularly. So someone with a trading fund of £1000 may decide to open trades for £20 per trade – representing 2% of the fund risking each trade. That the £20 trade size may remain in place until the fund reaches £1200 (or perhaps experiences a number of pullbacks and reaches £900). At this point the trade size can be adjusted.
So the calculation is not ongoing, but more of a benchmark for the next trading period. Some traders may re-initialize once a month, others at the end of each trading day. The mechanisms are not the key to the system – the main point is to risk only a small percentage of the total balance per trade.
Calculator Table
To assist in using the percentage rule trade size system, below is a quick table to indicate a quick trade size with different investment fund amounts and percentages. Those looking to take less risk per trade want to use a smaller percentage, and a larger percentage taking the risk. The fund size can also be multiplied, as can the percentages.
| 1% | 2% | 5% | |
| Total balance | |||
| £100 | £1 | £2 | £5 |
| £250 | £2.5 | £5 | £12.5 |
| £500 | £5 | £10 | £25 |
| £1000 | £10 | £20 | £50 |
The above calculator shows the importance of checking the minimum trade size with any potential broker if the investment fund is on the low side. Traders can easily find themselves taking on more risk per trade than they want because the minimum trade forces them to risk a larger than desired percentage of their total bank account.