Binary Options Trading

Managing Risk when trading Binary Options

One of the primary advantages of trading binary options is the much closer management of risk that comes with it when compared to many traditional forms of trading. Because both profit and loss are fixed from the outset, traders can be assured they will not lose more than they have invested, and they know their potential gain when they purchase a binary option contract. This allows them to develop much stronger strategies, freed from a number of variables present in other trading, and also frees them from worrying about how much exposure they are opening themselves to.

There are a few ways to further manage risk when trading binary options, simply by utilizing some basic techniques. One of the easiest ways to manage risk is to ensure one is never placed in a position without the capital to take advantage of future opportunities. Many people, once they have developed a strong binary option trading strategy, are tempted to invest the bulk of their capital in a single trade, to earn a large payout. While this is tempting, it should be avoided. Even the best binary option strategies can still run afoul of the unpredictable, and key fundamental events can swing the markets in a way that even the best analysts could not have foreseen. Investing no more than 5% to 10% of total capital ensures that even after a few unlucky trades, capital will still remain to rebuild.

More advanced binary option traders often use the practice of hedging to further manage the risk involved in binary option trading. Hedging involves taking out an opposite position in order to limit the loss that can occur. Binary options, because of the few variables involved, are very easy to hedge, and this can be an excellent way to limit exposure drastically.

The simplest type of hedging is taking an opposite position on the same asset, just at a different strike point. For example, let’s imagine Wheat is trading at $4.6900, and a trader expects it to drop in price, so they purchase a $1000 Put binary options contract on it. Now if the contract expires at $4.6899 or lower they are in-the-money and receive $1750 back, for a profit of $750. If it expires at $4.6901 or higher, they are out-of-the-money and receive $150 back, for a loss of $850. To hedge their binary option purchase, they would opt for a second contract, this time a Call contract. For example, let’s say that fifteen minutes after they purchased their first contract Wheat has dropped to $4.6895 – they are currently in-the-money, but they expect this to be the low point, and the asset could easily rebound before the expiration. In order to limit their risk, they buy a $1000 Call contract at that strike point.

Now if Wheat expires at $4.6901 or higher they are both in-the-money and out-of-the-money, receiving $1900, for a loss of only $100. If it breaks the resistance and continues dropping unexpectedly, they also receive $1900. And if it falls between the two points, where they expect it to, they receive $3500, for a profit of $1500. Their negative possibilities are now reduced to small $100 losses, rather than larger $850 losses, and their potential profit has doubled.