As with all forms of investment, trading in binary options carries a certain amount of risk. Hence, it is essential that a binary options trader has some form of risk management plan. There are several techniques that a trader can adopt in order to minimize his trading risk. Here are some of those techniques.
Risk Management Techniques
Risk to Reward Ratio
The fundamental reason for traders to having a trailing stop loss in a risk management plan is because they are able to maintain a constant risk to reward profile with their trade. For example, let’s say a trader decided that he wants to make 8% and is willing to risk a 3% move against him in his trade. Let’s further assume that the market moves by 5%, the trader should also adjust his stop loss upwards by the same ratio in order to maintain the same risk to reward profile.
Traders should refrain from moving their trailing stop loss to a level where the risk to reward ratio is higher than that which they initially decided upon when they entered the market once the market moves. In short, they should stick to the investment strategy that they first decided upon.
Managing Risk Through Portfolio Management
After a trader has build up several positions for their trading strategies, it is crucial that they analyze every position and see if there is a high level of correlation between the different market positions. The reason for this is because if there is a high level of correlation, this could result in an unacceptably high risk level. For example, a trader has a total of 8 positions which are highly correlated. If the market spiral downwards, this would mean all the 8 positions will move in tandem downwards possibly wiping out the trader’s entire portfolio. In short, this is like taking just one position in the market for the entire portfolio. A more prudent strategy for a trader would be make sure that some of his positions can mitigate the risks of the other position that he holds. This strategy is known as hedging the portfolio.
Hedging The Portfolio
Portfolios are considered hedged when a trader’s different market positions are not adversely affected by directional moves in the market. Let’s say a trader has a market position in which he is betting on the S&P 500 Index to rise. The trader can be considered hedged when he has a market position which bet on the S&P 500 Index to drop. This is one way how traders can mitigate their risk in trading.
The key to successful trading is to try and preserve your investment capital so that if today’s trading had not been profitable, you will still be able to trade the following day. A strategy which calls for a trader to bet everything that he has is a sure recipe for failure and should be avoided.
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