Many professional traders will agree that the ability to minimise the risk exposure of each trade is central to long term success. Whilst it may be easier for institutional traders to say this when commanding large accounts and implementing a company risk-policy, how can this be put in to practice by binary options traders?
Binary options trading is a fairly new method of investment available to retail traders, relative to stock and forex trading, which became increasingly accessible with the development of the internet. Initially, however, there was a large degree of misinformation relating to the risks involved in binary options trading. Several well-known investment publications proposed that it was both likely to scam traders and should be considered as gambling. It took some time for the early binary options brokers to be able to shake-off this misconception and luckily for many traders the early pioneers continued to improve over time.
Binary options as a regulated investment
One of the major concerns for sceptics of binary options trading was the lack of regulation in the early years. Since many were based in Cyprus it had the appearance of a risky venture for many, until these became fully-regulated under CySec, which now accounts for most of the binary options regulated brokers. In terms of risk, this has allowed many larger accounts to be set up with binary options as the credibility of brokers has increased and traders no longer feel that their capital may be at risk before they even begin trading. As the first and foremost criteria for lowing risk, traders should always look for a binary options broker that is regulated.
Binary options are at less risk from market volatility
Due to the “all-or-nothing” nature of binary options trading, there can only be two possible outcomes from a standard binary options investment. This will either result in a pre-determined gain or a pre-determined loss. Despite the fact that the markets that the binary option provide (such as forex, stocks and commodities) being subject to price volatility, the binary options themselves are at much lower risk of negative shocks than their traditional counterparts. Recent events, such as the uncapping of the Swiss Franc caused widespread market losses and many forex traders were unable to close their positions without incurring huge degrees of slippage. The risk level was pushed so high that some large brokers were even put out of business as a result of this market shock.
Binary options traders, however, were generally unaffected by this and their risk and exposure is not increased as a result of a sudden period of price volatility. This is due to the fact that all losses in binary options trading are known prior to purchasing the options. This loss cannot increase, regardless of how far price moves beyond the strike price. Since binary options only need to expire fractionally either side of the entry price in order to be profitable the degree of the move is irrelevant. In the event of a negative price move against a binary options trade, the irrelevance of stop-losses means that risk can also be managed by rolling over the options in the hope that price will recover or closing early to cut these pre-determined losses.
Strategies to reduce risk
There are also several strategies to mitigate risk in binary options trading which are not readily available to conventional forex or stock trades. This includes the ability to hedge a position in the same market, in order to have two open positions in opposing directions. Many may question the relevance of this possibility to lowering risk but it can be used a very effective way to reduce the possibility of some positions closing out of the money at the time of expiry. An example of this is trading a classic breakout scenario where price springs out a range and binary options are purchased in the direction of the move.
Since the momentum of such a breakout usually allows price to continue in this direction, they are usually considered as high-probability trades. However, if price quickly begins to return to the strike price and it is clear that the trade has failed a counter-trade in the opposing direction will create one winning and one losing position. Since many brokers offer insurance rates of 15%, this can be applied to further balance losses. This allows binary options traders to effectively only trade with winning breakouts.
RISK WARNING: YOUR CAPITAL MIGHT BE AT RISK